Contributed By Herbert Smith Freehills
The last 12 months have seen a focus on project financings in the commercial and industrial sectors, with a number of financings undertaken in respect of industrial operations (such as brown- and green-field factory developments of various sorts) and small-scale captive renewable power solutions for industrial off-takers. Also seen was the finalisation of the financing of some of the renewable energy projects from the fourth round of the Renewable Energy IPP Procurement Programme and interesting financings in the market that services domestic fibre optics infrastructure have occurred.
There have been limited project financings in the traditional sectors of PPPs and of the transport and infrastructure concessions. Nonetheless, there has been one accommodation PPP that is moving to financial close, and there have been financings (that should reach financial close in the near future) in the port sector and the transport infrastructure sector.
A marked trend in all transactions has been the need for innovative financing structures and out-of-the-box thinking to structure the transactions and the financing provided to them so that the transactions and the financing both work. This has resulted in hybrid debt structures with inflation-linked debt being paired with preference share financing; multiple debt tranches, some of which will only become available in the future when certain circumstances arise and there is a need to source mezzanine or alternate sources of financing to bridge gaps in the available senior debt and equity funding available for projects.
In a tight economic situation, there has been a need to wring the last drop of value from the financial structures and the financial model to meet the expectations of all participants:
South Africa has a deep pool of potential lenders and sponsors. The commercial banks are all active in the project finance markets and have deep resources available to them to provide finance to project finance transactions. A number of African and international DFIs (such as the DBSA, AfBD, EIB, AFD and IFC) are also active in the South African market. A growing number of debt funds also participate in the lending market, often as lead lenders.
The commercial lenders will often syndicate their loan positions to the pension funds and life assurance funds, who are usually eager holders of such debt, particularly if it is an inflation-linked instrument.
South Africa has a number of investment funds (such as Pembani Remgro, AIIF, PAIDF) that will provide equity for the projects and are experienced in project finance around Africa.
Historically, and currently, construction companies (such as WBHO and Aveng) have taken the lead in construction intensive projects, as the providers of equity and as developers and sponsors.
In the energy sector, there are a number of large international companies (such as Engie, Marubeni, ACWA, Scatec) and local companies (such as Mulilo, ACED) that play the role of project developers and sponsors.
South Africa has historically undertaken public-private partnerships (PPPs) in a number of sectors such as prisons, serviced office accommodation for government departments, public transport (such as the Gautrain), transport infrastructure, the health sector and the port sector.
There has been a lack of PPP and concession transactions in recent years, with the focus being on renewable energy IPP projects. However, in the last 12 months we have seen a revival of the PPP and concessions sector, with a few PPPs in the serviced office accommodation sector coming to market and some concessions in the port and transport infrastructure sectors moving to financial close.
Since June 2020, there has been increased hope of a revival in the PPP and concessions sectors with the announcement by the government that it intends to stimulate and revive the economy with infrastructure developments that require the participation of and partnership with the private sector.
In addition, in August 2020 the Risk Mitigation IPP Procurement Programme was launched with the issue of the RfP in respect of it. Government has announced that the Renewable Energy IPP Procurement Programme is expected to be launched in December 2020/January 2021.
Section 217 of the Constitution requires that all government procurement and all procurement by state-owned companies and agencies is undertaken in accordance with a system that is fair, equitable, competitive, transparent and cost-effective. The legislation set out below has been promulgated in order to implement these principles. Accordingly, all PPPs and concessions at a national or provincial level have to comply with the Public Finance Management Act (PFMA) and Treasury Regulation 16 (which is promulgated under the PFMA).
Likewise, all PPPs and concessions undertaken at a municipal level have to be undertaken in compliance with the Municipal Finance Management Act (MFMA) and the regulations issued under the MFMA, as well as in accordance with the provisions of the Municipal Systems Act.
The situation becomes more complex when state-owned companies are undertaking the PPP or concession, as there will need to be compliance with the PFMA, the specific legislation that creates the relevant state-owned company and either Treasury Regulation 16 or the supply chain management rules of the relevant company.
In addition to the legislation detailed above, there may be sector-specific legislation, such as:
It is important that all procurements of PPPs and concessions are done in accordance with the procurement processes and principles detailed in the relevant legislation, as failure to comply with those processes and principles could result in the procurement being set aside and struck down if challenged before the High Court.
It is extremely important that the deal is structured in order to comply with all applicable legislation and all authorisations, licences and permits that are required from government authorities. When structuring the deal, at the outset, it is important to do so in a way that will get such approval without the need to restructure to fall within the approval once obtained (which, unfortunately, occurs frequently). Application for the exchange control approval may only be made, and the approval itself will only be forthcoming, once the agreements are in their final form. Accordingly, there is a risk that the deal may need to be restructured once the approval is issued. When structuring the deal, tax considerations need to be taken into account.
Compliance with the requirements of the Broad-Based Black Economic Empowerment Act (BBBEE Act) and achieving a certain contributor status level will be a requirement of many project finance deals. This is particularly the case in respect of all PPP, concession and IPP projects entered into with a governmental body or state-owned company as a counterpart, where strict obligations will be imposed on the entity awarded the PPP, concession or IPP project to achieve and maintain compliance with a number of targets in respect of BBBEE or economic development (as it is often called).
The mining legislation also places obligations on companies active in the mining sector to achieve various targets in respect of BBBEE, and to continue achieving them once those targets are obtained. Further, due to governmental pressure on financial institutions and the private sector in general, there is also a growing requirement from financial institutions, investors and off-takers that project finance deals achieve certain BBBEE targets and that they continue to achieve those targets on an ongoing basis.
The South African market has deep financial and sophisticated financial resources. There are a number of equity investment funds seeking investment in viable project finance deals, as well as a number of sector-specific companies that will take developer-sponsor roles and invest equity in viable deals in their sectors.
Providing further depth to the financial resources available to provide equity, is the availability of bank debt to finance equity stakes. Both commercial banks and DFIs will provide equity finance to BBBEE companies in respect of their equity investments in deals and many developer-sponsors also raise equity finance to fund their equity investments in deals.
The debt financing available for projects can take various forms. South Africa has seen project bonds (albeit, in few deals). More traditionally, the debt takes the form of inflation-linked debt, or JIBAR-based debt (whether senior or mezzanine). Inflation-linked debt, or CPI debt as it is called, is usually sought out by pension funds and life assurance companies in the syndication market.
Preference share funding
Preference share funding is also available for specific transactions, and provides a useful debt instrument in deals experiencing certain types of cashflow.
Most transactions in South Africa (other than mining projects that sell their mineral extractions internationally) earn their revenues in rand, and this is particularly the case for all PPP, concession and IPP projects with governmental bodies and state-owned companies. Fortunately, South Africa has a large hedge market to enable hedging in respect of the rand (as well as in respect of commodity prices and interest rates).
Any assets (including rights) may be used for security. Accordingly, security is typically taken over:
It is possible to take general security over all present and future assets (including rights) of a company. The form of security taken over present and future physical assets is a general notarial bond, that is registered with the Deeds Office. The form of security taken over present and future right is a security cession. It must be noted that these forms of security do not grant real rights in the underlying assets and rights until the security is fully and completely perfected and enforced, which in the case of a general notarial bond, requires a High Court order and in the case of a security cession, requires the taking of possession or transfer of the rights.
Small registration fees are paid to the Deeds Office in respect of mortgage bonds and notarial bonds (special and general) on registration. These amounts are dependent on the value noted on these bonds and are not large in amount.
The largest fees will the legal fees paid to the attorneys preparing, settling and (if required) registering the security documents. There are tariffs that apply in respect of the legal fees for the preparation, settlement and registration of mortgage bonds and notarial bonds (special and general). These fees can be large, if the value on the face of the bond is large, but often the attorney will be prepared to agree to a lesser fee.
In order for a valid security interest to be created, there must an existing causa (namely, an existing and ongoing obligation owed by the grantor of the security to the person in whose favour the security is granted). This requirement applies in respect of all security.
There needs to be a detailed and comprehensive description of the land or the real right in land (such as a servitude or notarial lease over land) over which a mortgage bond is taken. In addition, it is necessary for the physical assets over which a special notarial bond is registered to have an individual and unique registration issued by the manufacturer of that physical asset. Accordingly, it is not possible to take these forms of security over assets that are not yet known.
It is not necessary for the assets or rights over which general notarial bonds and security cessions are take, to be individually identified. These assets and rights can be described in broad categories and classes and with general descriptions.
Generally, there are no restrictions on the grant of security or guarantees. However, if the creditor is a foreign entity, it will be necessary for the borrower or debtor to obtain an exchange approval from the Financial Surveillance Department of the South African Reserve Bank for the grant of security in respect of the indebtedness owed to the foreign creditor (see 4.1 Restrictions on Foreign Lenders Granting Loans).
In addition, the nature of the underlying asset may result in the application of certain legislation that places obstacles on the granting of security in favour of a foreign creditor (a prime example of such legislation is Section 11(3) of the Mineral and Petroleum Resources Development Act that requires the consent of the relevant government minister if security (namely, a mortgage bond) is granted over the mining right to any entity other than a South African registered bank). Accordingly, it is important to determine at the outset of the financing of any project, whether (dependent on the nature of the project and the assets) there are any obstacles in applicable legislation to the grant of the security in favour of a foreign creditor.
The only security that is centrally registered is mortgage bonds over land and rights in land, and general notarial bonds and special notarial bonds taken over movable assets. The Deeds Office can be checked to determine if the project company has granted any mortgage bonds or notarial bonds (whether special or general). No other forms of security (such as pledges or security cessions) are registered and the lenders generally rely on warranties, representations and undertakings from the borrower that it has not granted any such security.
Security is automatically released once the debt that it secures has been discharged fully and finally. Care needs to be taken in the drafting of the security documents that the security is not inadvertently released if the borrower does not owe the lender any monies for a short period or on a temporary basis.
More formally, the registration of mortgage bonds and notarial bonds (special and general) is usually cancelled at the Deeds Office following the full and final discharge of the debt. Pledges are cancelled by the return of the pledged asset to the owner. Security cessions are often cancelled by way of formal agreement between the cedant and the cessionary.
A secured lender may enforce the security granted to it for the amount of monies that are due and payable to it at that time. In order for the secured lender to enforce the security for the full amount of the debt owed to it, the full amount of debt must be currently due and payable (thus, not due and payable at a future date). This may mean that the secured lender has to accelerate the debt in full in order to enforce the security for the full amount in respect of which it is granted.
Upon the calling of a default and the acceleration of debt, the secured lender can notify the borrower that it is perfecting and enforcing its rights under the security cessions and any pledges (if there are any of the latter). This it may do by either selling and or transferring the assets or rights to a third party (such a substitute entity for the borrower), or by taking transfer of the assets or rights itself, provided that (in both instances) “fair market value” is given for the relevant asset or right. There is extensive case law as to what is meant by “fair market value” and essentially, it means the value at which the right or asset can be sold in the open market.
The situation in respect of mortgage bonds and notarial bonds (special and notarial) is more complex, as the secured lender has to get a court order before it can enforce the bonds. Upon the issue of the court order, the secured lender will have to sell and transfer the asset or rights to a third party (such as a substitute entity for the borrower) at a market-related price.
A choice of foreign law as the governing law of the contract and submission to a foreign jurisdiction will be upheld in South Africa.
South Africa is a signatory to the New York Convention, so arbitral awards granted in other countries that are signatories to the New York Convention are enforceable in South Africa. Judgments awarded by foreign courts may be made an order of the South African High Court provided that the relevant judgment is final, non-appealable, not in contravention of any South African laws and does not contravene the bonos mores of South Africa.
Subject to the grant of an exchange approval from the Financial Surveillance Department of the South African Reserve Bank for the grant of security in respect of the indebtedness owed to the foreign creditor, and (in the case of litigation) the foreign creditor complying with the rules of the High Court of South Africa, there are no other matters that could impact on a foreign lender’s ability to enforce either the finance documents or the security documents.
In order for a South African entity (whether a natural person or a legal entity) to borrow money from a foreign lender, it must obtain the prior consent of the Financial Surveillance Department (FSD) of the South African Reserve Bank (SARB). The FSD administers the Exchange Control Regulations, 1961 (issued in terms of the Currency and Exchanges Act, 1933). The approvals granted by the FSD are called “exchange control approvals” or “excon approvals” for short. These approvals need to cover all aspects of the transaction and it is fundamentally important to inform the FSD of all aspects of the transaction, as the omission of any issue that the FSD deems important could nullify the approval. At the outset of a transaction involving any foreign lenders or investors, it is important to ascertain what excon approvals are required and whether these approvals are likely to be forthcoming.
It is not possible to deal with the FSD directly and all dealings with them must be through an authorised dealer, whom the FSD has appointed to deal with it and handle applications for excon approval. All the South African banks have been appointed as authorised dealers as have the branch offices of many foreign banks registered in South Africa.
The excon approval will need to cover all aspects of the transaction, such as the amount of monies loaned, the interest rate and the base interest rate, as well as the principal repayment and interest payment profiles and the extent and nature of the security given to secure the loan. Generally, consent is not given for South African companies to hold foreign currency balances in bank accounts for more than a limited period of time nor to hold foreign currency balances in offshore accounts, as security for the secured lenders.
Application can only be made to the FSD for excon approval once the agreements in respect of the transaction are in final form, and the excon approval will only be forthcoming once the deal is in final form. Accordingly, it is extremely important to bear the exchange control issues and principles in mind the whole time that the deal is being developed, in order to avoid having to restructure aspects of it at the end, if excon approval is declined (which does happen).
Security can be given to foreign lenders, provided the application for excon approval sets out the security required to be given to the foreign lender.
Investments into project companies, whether in the form of the holding of share capital and or the making of shareholder loans will require prior excon approval from the FSD. It is important to obtain that approval before the investment is made and the excon approval should cover all aspects of the investment, such as the price that was paid for the investment, the manner in which it is structured, when and how payments will be made in respect of the investment to the investor and any interest rates that are applicable.
Limitations are placed on the borrowings that a foreign-controlled South African company can make in the South African market. A South African company is foreign controlled if it is 75% or more owned or controlled by a foreign entity.
Consideration should be given to the tax aspects of the investment, as it may be advisable to made the investment via a country with whom South Africa has an agreement for the avoidance of double tax.
Any payments abroad or repatriation of capital is subject to the consent of the FSD, which is why it is important to obtain the excon approval in respect of the future payments abroad and the repatriation of capital before the investment or loan is made. Generally, there are no problems if the payments and repatriation are made in accordance with the excon approval.
South African companies are not permitted to maintain offshore foreign currency accounts without the permission of the Financial Surveillance Department of the South African Reserve Bank, in terms of the Exchange Control Regulations. The FSD very seldom, if ever, grants such permission.
Finance and project agreements do not need to be registered or filed with any authority. Security documents that grant a real right in the relevant asset (namely, mortgage bonds registered over land and special notarial bonds registered over movable assets that have an unique and individual registration number from the manufacturer) need to be registered with the Registrar of Deeds.
South African law requires all companies that are conducting business to be incorporated in South Africa. Whilst there is no prohibition on foreign entities owning land, it is not possible for them to hold mining rights, electricity generation licences or the other consents, authorisations and approvals that might be required to conduct a particular business (such as water use licences, environmental authorisations and the various licences that the municipality within which they conduct their business may require them to hold). In addition, the government departments and state-owned companies will not enter into PPP agreements, concession agreements or PPAs that are to be conducted within South Africa’s borders, with companies incorporated outside of South Africa.
Whilst there is no requirement for a general licence to undertake business activities, depending on the nature of the project that is being undertaken, there may be a requirement for certain types of licences, such as:
Accordingly, it is important to ascertain at the outset what approvals, consents, licences and authorisations are required and what the time lines are to obtain these approvals, as the time lines can be lengthy, especially if a public consultation and participation process needs to be conducted.
All companies must be registered with the South African Revenue Service for income tax and VAT purposes.
Agency and trust concepts are recognised in South African law. En commandite partnerships are also often used in respect of the structuring of investment or private equity funds. However, certain legislative provisions prohibit the holding of security by an agent on behalf of lenders and generally, the common law is not clear that security can be held by an agent on behalf of the lenders. Accordingly, the practice in respect of the taking of security on behalf of the lenders is to have a special purpose company hold that security, using a debt guarantee and indemnity structure, rather than a security agent.
In respect of the registered security (namely mortgage bonds and notarial bonds), the bond that is registered first in time takes precedence and priority over the bonds that are registered later in time. The bonds that are registered later in time will require the consent of the existing bond holder to be registered.
In respect of the other security, such as security cessions, the oldest security takes precedence over the later security.
Contractual subordination is common and will survive the insolvency of the borrower. However, the wording of the subordination will determine the extent of the subordination and whether the subordination is in favour of one creditor or all creditors generally. In addition, it is possible for creditors to agree amongst themselves and with the borrower to vary their ranking and priority for payment. Whether this variation of priority and ranking is enforceable against a liquidator of the borrower or only against the fellow creditors who entered into the agreement to vary the priority and ranking, will depend on the wording of the subordination or priority ranking. Accordingly, the wording of the contractual arrangements is very important.
South African law requires that any company conducting business in South Africa must be incorporated under the Companies Act, 2008. This principle would apply to any project company. South African law allows a private company or a public company, both of which are limited liability entities, being separate legal entities from their shareholders. Generally, project companies are private, rather than public, companies, as the regulatory requirements in respect of private companies are less onerous than those of a public company.
The Companies Act, 2008 contains a regime for the compromises or arrangements between a company and its creditors or a class of its creditors. Such compromises or arrangements can take place whether or not a company is financially distressed.
The Companies Act, 2008 also sets out the business rescue process that can be applied to financially distressed companies, that could be rehabilitated (in the language of the Companies Act). This process is used often in respect of companies that are experiencing financial distress, as a means to give themselves an opportunity to restructure themselves and become viable businesses again. The commencement of a business rescue process can be voluntary and initiated by the company itself, or it can be initiated by a third party, such as a creditor.
Insolvency of companies is regulated by the Insolvency Act, 1936. Once a company has been placed in liquidation, the usual outcome is the realisation of the assets of the company and the settlement of its obligations to the extent possible using the proceeds raised from the sale of the assets. The liquidation process can be voluntary (initiated by the company itself) or involuntary, initiated by a third-party creditor.
Once a business rescue process has commenced, the business rescue practitioner can place a moratorium on the servicing of any financial obligations whilst the business rescue process is underway. In addition, there is a general moratorium on any legal actions, including enforcement actions, against the company. This means that the security cannot be enforced at this time. Any creditors with a claim against the company in business rescue need to ensure that they lodge their claims against the company, with the business rescue practitioner within the relevant deadlines.
Once a company is in liquidation, the lenders cannot take legal action (including enforcement of the security) against the company. In addition, the liquidator has the powers to revisit various transactions (such as the granting of security and the disposal of assets) undertaken up to two years (in some instances) and up to six months (in other instances) prior to the company being placed in liquidation in order to determine whether those transactions resulted in the undue preference of one creditor over the other creditors. If such undue preference was created, the liquidator can set the transaction aside.
The lenders need to ensure, in respect of a company in liquidation, that they team up with other creditors holding large claims to ensure that their choice of liquidator is appointed as the liquidator, attend all creditors’ meetings, to lodge their claims with the liquidator and to ensure that they are paid the proceeds of any secured assets that are secured in their favour.
Creditors are paid in the following priority:
The main risk for the lenders when a creditor is placed in business rescue is the moratorium that can be placed on the servicing of the debt (with respect to the payment of principal and interest) and the general moratorium that is placed on their ability to take enforcement action against the company. In addition, business rescue processes have tended to take longer than anticipated and the lenders have had to carry non-performing debt for lengthy periods of time.
The one of the main risk for lenders when a creditor is in liquidation, is that their security could be set aside if it is successfully attacked by the liquidator on the grounds that it was a voidable disposition or that it created undue preference in their favour or that it was a disposition not made for value (in terms of Sections 26, 29 and 30 of the Insolvency Act). Certain liquidators make a practice of attacking security and dispositions on these grounds if the security was granted or the disposition was undertaken within the relevant time periods.
An additional risk is that the value of the assets secured in favour of the lenders are not realised for an amount that is large enough to settle the full amounts owed to the lenders. The lenders will be concurrent creditors in respect of the monies owed to them that were not settled by the proceeds from the realisation of the security.
Finally, liquidation processes can take a lengthy period of time and it could be a significant period of time before the lender receives any payment in respect of the debt owed to it.
No legal entities are excluded or protected from liquidation or creditors proceedings to place them in business rescue. The legislation that creates certain state-owned companies (such as Eskom) can only be liquidated if parliament places them in liquidation. However, not all state-owned companies benefit from such provisions in the legislation that creates them. In addition, those provisions in the legislation do not prevent creditors from suing the relevant state-owned companies to recover the monies owed to them or from applying to the High Court to place the state-owned company into business rescue.
There are no restrictions or controls in respect of insurance policies over project assets, other than the requirement that the purchaser of the insurance has an insurable interest (which the owner of the project asset will have). Premiums and broker fees are paid in respect of insurance policies purchased, but there are no additional fees imposed by the government. The purchaser of the insurance will be required to pay value added tax on the premiums and the broker fees, in according with the prevailing value added tax regime.
Provided the South African debtor has obtained a comprehensive Excon Approval from the FSD, which includes the fact that the proceeds of the insurance policies may be used to settle the financial obligations owed to foreign creditors, the foreign creditors may be paid the proceeds of the insurance policies over the project assets.
Generally, withholding tax at a flat rate of 15% is imposed by the South African Revenue Service (SARS) on interest (but not principal) payable to foreign lenders. The tax is due by the foreign lender but the entity paying the interest is required to withhold the tax amount from the interest payment and to pay it to SARS. However, it is advisable to ascertain whether any exemptions or any agreement for the avoidance of double taxation apply, resulting in a total exemption from the withholding tax or a reduced taxation rate being applicable.
Generally, the income tax and value added tax regimes of South Africa will apply to the project company. If the project is dependent on imported components, equipment and materials, customs excise duties will be applicable and it is important that the rate and possible amount of these duties be ascertained.
The Consumer Protection Act, which is South Africa’s anti-usury legislation, does not apply to complex, sophisticated project finance transactions. It is, however, important to note that the approval of the FSD will be required in respect of the interest rate that is charged by foreign lenders to South African lenders and the FSD will not consent to an interest rate that exceeds a certain number of basis points above the interest rate in the home jurisdiction of the relevant currency. The excess number of basis points that the FSD is prepared to approve does vary from time to time, depending on the macro economic situation at the time.
In addition, the in duplum rule does not permit accrued and capitalised interest to exceed the amount of the initial principal loaned. This rule is not applicable if interest is being regularly serviced, but only if interest is not being serviced and is allowed to be capitalised.
Typically, project agreements are governed by South African law. In particular, agreements with governmental departments (national, provincial and municipal) and state-owned companies are invariably governed by South African law. However, there is no prohibition on having a governing law other than South African law.
Finance agreements are usually governed by South African law and security documents taken over assets in South Africa must be governed by South African law. Again, there is no prohibition on having a governing law other than South African law.
Typically, all aspects of a project situated in South Africa are governed by South African law. Depending on the nature of the project, a number of consents, licences and authorisations may be required in respect of the project (such as environmental authorisations) and these will all be governed by South African law. South African law may have certain requirements in respect of various aspects of a project (such as rights or ownership of land or rights attaching to shares in a company), with which there must be adherence.