Power needs in Saudi Arabia have increased at an impressive rate over the past years and current estimates indicate that, due to demand growth averaging 5% to 7% annually until 2020, the current installed generating capacity of 26,326MW should increase even more significantly (20,000MW are anticipated) to meet these requirements. Consequently the sector is looking to independent power developers for more capacity.

In February 2003 Crédit Agricole Indosuez (CAI) and Banque Saudi Fransi were jointly mandated by Jubail Energy Company (JEC), a joint venture between CMS Generation and National Power Company (itself a joint-venture between the Al-Zamil Group and the El-Seif Group) to arrange and underwrite the total debt package for the first Saudi independent power project.

In parallel, the lenders, advised by Allen & Overy, as international counsel, and the Alliance, as local counsel, managed to devise a bankable structure within five months from mandate to financial close and drawdown in a challenging legal and political environment: syndication of the project was launched in Bahrain on 12 May 2003, the day following the deadly attacks in Riyadh.

The points described below illustrate some of the specific issues which lenders, sponsors and offtaker had to overcome to close this Saudi template.

Key project issues

The most challenging aspects of the project for the banks were related to the security structure and the creation of an effective bridge between the needs of an international non-recourse financing and project documents regulated under local law.

An example of the challenges posed by Saudi law governed project documents arose in relation to JEC's property interests.

JEC holds the project site on a sub-lease from SADAF, which in turn, holds its site on a primary lease from the Royal Commission (essentially the administrative body overseeing the Jubail Industrial City). The Royal Commission is a body fast having to familiarise itself with project finance structures and typical lender concerns and requirements. However, the tight timetable to financial close meant that the protections which lenders might commonly seek were not available.

In particular, there was no direct agreement with the Royal Commission in respect of the property arrangements and therefore other documents had to be used to address the risks of changes to, and termination of, the primary lease in a manner satisfactory to the lenders. The parties agreed to use the ECA (Energy Conversion Agreement - the project's offtake agreement) events of default to allocate risk, while the direct agreement in respect of the ECA also provided a direct link between the lenders and SADAF in which peculiarities in the sub-lease agreement (and the consent agreement from the Royal Commission in relation to the granting of that sub-lease) could be addressed.

Security Package

Saudi law imposes a number of restrictions on the taking of security. While assignments of contractual rights are possible, mortgages cannot be registered, and security over movables effectively requires actual possession and cannot therefore be perfected. In addition, a share pledge over the project company, a key element of a traditional security package, cannot be achieved as shareholders in Saudi limited liability companies, such as JEC, cannot effectively waive their pre-emptive rights in relation to the transfer or sale of these shares. This comes, as further discussed below, in addition to the difficulties linked to the absence of injunctive relief or ability to call for specific performance of contracts under Saudi law.

How then can lenders synthesise the two key elements they seek in a security package: control over the project assets in the event of a default and the ability to realise these assets on an enforcement scenario? Moreover, how to balance the needs of the lenders for a 'real' security package in a challenging legal environment, with the needs of the project for a practical and reasonably simple solution?

The approach finally agreed by the parties was to rely on indirect share security over the shares in JEC's holding companies (respectively in Bahrain for NPC and the Cayman Islands for CMS). Given the indirect nature of the share security, and the lack of a proprietary interest in JEC, the lenders also required contractual undertakings from these holding companies to control their dealings in the capital of JEC on specific issues. For example, the holding companies agreed to undertake to the lenders not to dispose of their shares in JEC without consent and to otherwise preserve the ownership structure established as at financial close.

These contractual obligations were bolstered by the issue of powers of attorney to allow the lenders to effect the sale of JEC's shares, as well as signed and undated directors' resignation letters together with signed and undated shareholders' resolutions allowing the lenders to appoint alternative management in an enforcement scenario. While not a true substitute for effective asset security and direct share security, the lenders accepted this approach as being adequate to mitigate their concerns. In the light of this compromise, the lenders decided to focus on strengthening other aspects of the project, particularly those related to the ECA termination payments.

The SADAF Corporate Loan: The key bridge

The main challenge in structuring the transaction was to bridge the requirements of Shari'a law principles governing the project documents with the needs of a conventional project finance syndicate. It was key to the syndicate that termination payments under the ECA be preserved to repay the debt if the project defaulted, particularly as Shari'a law would render the interest component unenforceable. SADAF also wanted to keep the flexibility to spread the termination payments over time.

To build this bridge, it was important to look at the dispute resolution bodies in Saudi Arabia. Commercial contract disputes are heard by the Saudi Board of Grievances, which by experience, tends to take a strict Shari'a approach. Banking disputes, however, are heard by the Saudi Arabian Monetary Agency (SAMA) Committee, which is often viewed as more commercially oriented. Given that the termination payments would, at least in part, be used to repay the debt, the parties found a common ground in structuring the element representing outstanding senior debt as a direct corporate loan (the Corporate Loan) from SADAF to the banks.

The Corporate Loan, which springs on termination of the ECA, was the innovation suggested by the lenders and their lawyers that made the bridge between Shari'a and conventional project finance interests possible. It gives a discharge of the JEC project debt to the extent of the debt component (principal and interest) of the termination payment and, in its place, SADAF becomes indebted to the lenders in the same amount. The Corporate Loan is an agreement governed by English law and international arbitration, with any enforcement in the Kingdom being referred to the SAMA Committee. This mechanism mitigates the risk of Shari'a law not enforcing interest amounts by calculating the relevant part of the termination payments under English law and allowing their enforcement before the SAMA Committee.

Rather than waiting for termination of the ECA to occur before signing the Corporate Loan, and given the concerns as to the lack of specific performance remedies in the Kingdom, the parties agreed to cement their understanding by signing the Corporate Loan at financial close. It was a critical principle that SADAF should not be deemed to be indebted to the lenders unless and until the ECA terminated and a termination payment became due. Therefore, the Corporate Loan lies entirely dormant until such termination, at which point it 'crystallises' and SADAF's indebtedness arises. SADAF is then obliged to repay the Corporate Loan over a four year period, thus giving it the flexibility requested to spread payment of the termination amount. This structure is clearly a new departure in project finance where termination payments are usually made in one lump sum amount.

Given the particular novelty aspect of this deemed loan, SADAF agreed to enhance this structure by providing promissory notes, which evidence the deemed indebtedness of the offtaker. These promissory notes were also signed in blank at financial close, in the light of the same specific performance concerns outlined above.

Finally, to tie JEC, the lenders and the offtaker to the Corporate Loan structure, the parties signed a tripartite agreement, which ensured that: (i) for JEC, the project debt would be discharged to the extent of the Corporate Loan, (ii) for SADAF, assurance would be obtained that no calls would be made under either the Corporate Loan or the promissory notes until the ECA was terminated and a resulting termination payment fell due, and finally (iii) for the lenders, the outstanding debt would be repaid.

Setting the benchmark

The challenges posed by the novelty of the structure in the context of precedent Saudi financings combined with the tight timing required to close were addressed by solid project fundamentals, strong commitment from the sponsors and SADAF and innovative structuring of the contractual framework from the lenders and their lawyers. Although small in terms of size and financing, the successful closing of this transaction now sets a benchmark for the future of power projects in the Kingdom.

The transaction was successfully placed prior to financial close in the local and regional market with three institutions: APICORP, Arab National Bank and Riyad Bank, as there was no need to syndicate the debt to a large number of banks, given the deal size.

A number of lessons learnt by all parties during this exercise should now prove useful for developers and lenders in the upcoming portfolio of Saudi power transactions. These include the next transaction, which is currently being structured: a set of four IPPs developed for the benefit of Saudi Aramco, while, in the short-term the Water and Electricity Company intends to select a developer for the 700MW and 175MIGD desalinated water IWPP plant located at Shoaiba.