The insurance policies and the proceeds receivable are an asset of the business over which the lenders will take security in the same way as any other asset of the project. In addition to assignment of the insurance rights there is a fairly standard suite of lender requirements that are applied to internationally financed projects. These requirements are largely based on English law but most of them have application globally, however some are unnecessary due to local insurance law but still regarded as good practice and some and not legal by local laws or might attract stamp duties (from cut-through agreements or assignments, see below) so are not advisable. Depending on which endorsements the insurers will agree to, it may not be advisable to require others. For instance, if the insurers do not agree to include a non-vitiation clause (see below), do not agree to waive the lenders’ duty of disclosure nor waive the lenders liability for the premium, then the lenders might be best advised not to be an insured party (those things can only apply to insured parties) and simply rely on loss payee provisions.
Insurance policies are not contracts of insurance, they evidence that an insurance contract exists and the overall contract includes the provisions of the insurance laws of the relevant country governing the policy and all disclosures made in the course of procuring the insurance. Insurance policies are also policies of indemnity, that is, they indemnify the insured parties for their legally recognized insurable interest in the risk that is insured. As will be seen below, simply being a named insured does not automatically entitle that person to make a claim if they do not hold the insurable interest. For instance, the lender’s insurable interest in the asset is the outstanding debt.
For the purpose of this chapter we will address the English law position.
CO-InSureD AnD InDeMnITy
The lenders will require to be named as an insured party under the principal insurance policies and by doing so the insurers undertake to indemnify them in respect of their insurable interest in the insurance. By being an insured party all the terms and conditions, implied and actual, may equally apply to each insured party such as be jointly and severally liable for the premium. This can vary where for instance aviation insurance policies typically differentiate between principal insured and additional insured where the additional insured are exempt from certain conditions such as the payment of the premium. So depending on the structure of the policy, being an insured party has its benefits but also has its risks, one of them being that each insured may be equally capable of invalidating the insurance for the other parties.
Lenders are also required to be an insured party in the liability insurance. As will be seen above, a liability policy indemnifies the insured party for their liability at law arising out of the insured business (design, build, finance and operate the project). It is difficult to see how a lender will be held liable for the acts and omissions of the borrower in building or operating the project so being a co-insured under the liability insurance has no real practical benefit save for some comfort that if someone tried to join the lenders in an action, the lenders would be entitled to the benefit of the policy.
DISClOSure
As stated above all insured parties have a duty to disclose all material facts, which are those facts that would influence the mind of a prudent underwriter whether to underwrite the risk and on what terms. Project companies are typically special purpose companies established as the vehicle for procuring and financing the project and they subcontract the activities to builders and operators. The project company would typically arrange the insurance and are, therefore, dependent on the builder or operator, as appropriate, to provide the underwriting information. Failure to disclose material information may enable the insurer to avoid the claim or even void the policy in its entirety from its beginning. It is a standard practice for the lenders to have their duty of disclosure waived under the insurance. This is crucial for the lenders because they are insured parties and rely on the insurance. They however, are not party to the actual procurement of the insurance yet they have a considerable amount of information on the project including reports from technical advisers, insurance advisers and lawyers. The lenders would not want their interest in the insurance to be undermined because another insured party failed to disclose a material fact.
lIABIlITy FOr PreMIuM
All insured parties are potentially jointly and severally liable for the premium. This is unpalatable to the lenders so they would require the insurance to be endorsed to remove them from this liability. As there is no insurance contract if the premium is not paid, the lenders reserve the right to pay the premium but as a right not an obligation.
nOn-vITIATIOn
The ability for insurers to avoid a claim from one insured party due to a breach of the policy by another insured party varies by local laws and policy structure and conditions.
Regardless, it is standard practice in project finance to endorse the policy so that the insurers agree that the insurable interests of the parties that are innocent of the breach are not prejudiced. Some insurers retain the right to recover their loss from the vitiating party where but for the non-vitiation clause, they would have been able to avoid the claim.
The issue to the lender is that the party who vitiated the insurance may have been the borrower and in which case, if the lender is able to make a claim for its insurable interest, the insurer could then claw it back by exercising its subrogation rights.
Further, merely being an insured party does not necessarily entitle another insured party to step in and make the claim. As stated above, lenders are co-insured under the liability policy. As the policy is indemnifying the insured parties for their legal liability arising out of the business, then unless the lenders are also held legally liable, they would not be able to step in and make the claim even though their borrower now has an uninsured liability. This is because the policy is covering the legal liabilities of the insured parties not the lenders’ credit risk in the borrower.
ASSIGnMenT
The insurance policies and the proceeds under them are assets of the project company and lenders will take security over them through an assignment agreement. Insurance policies are not freely assignable (with minor exception such as marine cargo policies) and therefore, such assignment is not valid under the insurance unless agreed by the insurers. Consequently, an endorsement on the policy is an agreement to the assignment by the insurers. That will deal with insurance policy but it is normal practice to also serve a notice of assignment on the insurers which is to satisfy UK property law, not insurance law.
Assignment is a legal process requiring legal advice but could also be a tax issue where in some territories it could attract stamp duties as a transfer of property.
In territories where insurance regulations require insurance with local insurers but those insurers do not have sufficient credit ratings to satisfy the lenders it would be normal to require the insurance to be reinsured into the international reinsurance market to the maximum amount permitted and lenders would seek assignment of the reinsurance proceeds. Again, local regulations or solvency laws may not permit direct payment to the lenders.
lOSS PAyee
Insurance policies indemnify the insured parties for their insurable interest in the thing being insured. Lenders will want to regulate all receipts of the project company and consequently will require the insurers to agree to pay all proceeds to certain bank accounts except with regard to liability insurance, where they will agree that the insurers may pay the injured party directly. This overcomes the issue that whilst the lender may not have the insurable interest in the entire claim and, therefore, are not entitled to the
full amount from the insurers, they are able to control those proceeds. Again, local laws or tax considerations may prevent payment of proceeds in this manner.
PrIMAry InSurAnCe
Where the same insurable interest in the same risk is insured under more than one policy of insurance there may be local rules as to which policy pays the loss or how the loss is shared by those policies. This is not acceptable to lenders as they have provided a loan on the basis of a specific set of insurance policies, they have vetted those policies, accepted the insurers, may have approved the reinsurance and taken security over them. To find that all or part of the loss is now to be pursued through a ‘non-compliant’ insurance would undermine their security. Consequently lenders would require the project insurers to agree that their policy is primary and would not seek contribution from other insurance policies before paying the claim.
nOTIFICATIOnS
The loan agreement would impose obligations on the borrower to notify the lenders in the event that the insurance is cancelled, suspended or adversely altered. Lenders also require the insurer and reinsurer where applicable, to notify the lenders in such circumstances and require a minimum amount of notice. In the event that the insurer is giving notice for non-payment of the premium, the lenders may cause it to be paid or pay it themselves and recover from the borrower. For other reasons of cancellation or suspension, the lenders can consult and monitor the borrower’s effort to replace the insurance.
In the case of breach of the borrower’s insurance obligations the lenders have the right to step in and affect the insurance, but that is not as easy as it sounds!
Lenders usually include an obligation for the insurer to notify lenders if the policy is lapsed. Typically, insurers do not agree to that and only agree to notify things that happen during the policy period, not at the end of it. Lenders need to ensure that they receive evidence that the insurance is renewed at the end of each policy term, prior to the insurance cover running out.
Typically, but not in all territories, the borrower employs the services of an insurance broker to negotiate and arrange the insurance as agent of the borrower. In those cases, the lenders will also require the broker to undertake to give similar notifications to the lenders. See broker letter of undertaking below.
InSurer SeCurITy
Probably every country in the world has regulations controlling who can transact insurance in the country and insurance that is required by law tends to be more tightly controlled. Commonly, insurance needs to be purchased from insurers in the country in which the project is sited. In Europe, the European Union freedom of services legislation permits, with some conditions and exceptions, persons in one member state to insure with insurers in another member state. Insurers, however, would typically have greater freedom to arrange reinsurance in the international insurance markets. This is for practical
purposes where the local insurers may not have the capacity to retain all the risks that they underwrite and need to cede some of the risk to other insurers, i.e., re-insure.
Where the local insurer does not meet their minimum credit rating level the lenders would require reinsurance with international reinsurers who do meet their minimum standards. They would want the reinsurance to be project specific (known as facultative reinsurance) rather than under the insurer’s general reinsurance arrangements (reinsurance treaties). The lenders’ reason for requiring international reinsurance may not be restricted to the liquidity of the insurer but may also be for exchange control purposes where the proceeds are paid into an ‘offshore’ bank account (some countries require reinsurance proceeds to be paid to the local insurer).
Where permitted by law and provided that it does not have tax implications, e.g., stamp duty, lenders will take security over the reinsurance with similar provisions as for the local insurance such as the notification requirements, loss payee provisions, primary insurance and suchlike. Where possible they may take assignment of the reinsurance. As the reinsurance is a contract between the insurer and the reinsurer the lenders will need to enter an assignment with the insurer and the insurer will have to agree it with the reinsurer.
BrOker leTTer OF unDerTAkInG
The status of the insurance broker is that they are normally an agent of the insured, not the insurer. The broker will enter a service agreement with the borrower under which he may or may not limit his liability.
The role of the broker is much wider than just arranging the insurance. He collects the premium from the borrower and pays the insurers (there may be several) and also may collect claims proceeds and pay the borrower. Some insurers such as Lloyd’s Underwriters in Lloyd’s of London, can only operate through the Lloyd’s broker so in practice they are not able to notify the lenders of cancellation, etc., and as for loss payee they can only cause the broker to pay the proceeds into the designated bank account.
The broker letter of undertaking creates a legal relationship between the broker and the lenders under which the broker commits to the lenders various notification obligations, money handling commitments, provide evidence of the insurance and confirm that to the best of their knowledge the insurers are solvent and the cover is in full force and effect. The broker cannot warrant that the insurer is solvent nor can they warrant that the insurance is in force because unknown to the broker the borrower may have failed to disclose material information thereby undermining the validity of the insurance. The broker may or may not cap his liability under that letter.
Reinsurance is a separate agreement between the insurer and the reinsurer and there would be a service agreement between the reinsurance broker (who may be the same as the broker) and the insurer. Consequently, as the lenders will be relying on the more robust reinsurance, they would also need to obtain a reinsurance broker letter of undertaking along the same lines as the broker letter of undertaking.
rOle OF InSurAnCe/reInSurAnCe BrOker
Typically, the project company would employ the services of an insurance broker to advise them on their risk management strategy including insurance needs, design the
insurance programme, tender the insurance, negotiate the terms for them and place the insurance. The broker would then have an on-going role to agree the policy wordings, advise on changes throughout the period of insurance and may be engaged to advise on claims under the policies. This is not always the case and in some territories the project company deals directly with the insurers.
In some territories the local insurers do not have the ability or desire to retain the entire risk or, regardless of the local insurer risk management strategy, the lenders or project company may require more robust security and cause the insurer to reinsure with more acceptable reinsurers.
Contractually, the insurance broker is an agent of the project company arranging the insurance with the insurer. The insurer would then employ a reinsurance broker as its agent to arrange the reinsurance with the reinsurer. In practice the price and cover under the insurance is driven by the availability and price of the reinsurance so the reinsurance broker would actually design the insurance programme and seek project-specific reinsurance to satisfy the needs of the project company and their lenders. Then the insurer can offer their insurance to the project company. This is why the reinsurance broker and the insurance broker are normally from the same firm as the two roles are far more synchronized than the contract structure would suggest.
rOle OF lenDer InSurAnCe ADvISer
Fundamentally, the project company is presenting its business case to the lenders including its proposal for insuring the project. In the same way that the lenders’ technical adviser reviews the design and working methods, etc. for building and operating the project, the lender insurance adviser reviews the risk management proposal of the borrower. It is not the role of the lender insurance adviser to design the insurance solutions.
The lender insurance adviser should review the risks to the project recognizing the nature of the debt and how those risks have been allocated under the principal contracts.
Having undertaken that risk profile, the lender insurance adviser can review and benchmark the project company’s insurance proposals in order to opine as to whether it is appropriate and if not, to negotiate or recommend improvements. Lenders also want to know what risks are not covered so that they can ensure that the risks are managed through contract, contingency or otherwise as outlined at the beginning of this chapter.
The lender insurance adviser would liaise with the legal and technical advisers as well as with the lenders and the project company in order to carry out its services. Having agreed the minimum insurance requirements and which aspects of the lenders security package are to be applied to the respective insurance policies, the lender insurance adviser would liaise with the lawyers to document those requirements into the loan agreement and subcontracts. Prior to financial close, the project company would submit evidence of the insurance and reinsurance, the broker and reinsurance broker would provide their letters of undertaking and the lender insurance adviser would audit them against the loan agreement and complete their final report to the lenders summarizing all of the above and confirming that the insurance documentation complies with the loan agreement.
The lender insurance adviser would normally be retained to review the insurance when they move from construction into operation and at each renewal date until the loan is repaid. The lender insurance adviser should be an integral party to the diligence team.
Their sole duty of care would be to the lenders.
chapter
11 The Equator Principles – The Global Standard
Suellen lAzAruS Independent consultant
When 10 international banks announced their commitment to adopt the Equator Principles (EPs) in June 2003, it signalled a dramatic change in the international banking community’s approach to environmental and social issues in their project finance lending.
The decision to apply a comprehensive set of environmental and social standards to a high profile and often core business-line began a process of coordination among financial
The decision to apply a comprehensive set of environmental and social standards to a high profile and often core business-line began a process of coordination among financial