30 January 2024
Written by Ariana Wu
In project finance, full recourse financing provides the Lender an “all monies” claim on the Project Sponsor’s assets, extending to all obligation owed by each borrower and each other guarantor. In some large projects, the Project Sponsor will tend to limit their responsibility and exposure in the event of default under the loan. Thus, they will tend to a different financing structure, which is known as limited recourse financing.
What is Limited Recourse Financing?
Limited recourse financing, as its name suggests, is where a Lender has a limited claim on the assets of the project if the Borrower fails to generate sufficient cash flow to repay the debt. It is often used in Project Finance or Property Finance when a Lender relies upon the cash flow and assets of the project for repayment and security, as the loan’s security is limited to certain assets and entities.
What is the Impact of Limited Recourse and Potential Risk to the Lender?
The impact of limited recourse finance is significant for both the Lender and the Project Sponsors. On the positive side, limited recourse provides protection for a Project Sponsor by shielding the Sponsor’s other assets from potential seizure and enforcement. It is preferred for those Project Sponsors who have multiple projects, because it allows each project to be completely segregated. For the Lender, the impact is twofold. Limited recourse finance can be tailored to attract more Lenders, including banks, institutional lenders, and alternative capital providers to participate in financing because their downside risk is confined to the project itself. However, it may also result in higher interest rates or stricter terms as Lenders are taking on greater risk compared to full resource financing.
In the current market, there are two approaches in limited recourse financing. One approach is the Lender lends directly to the Project Sponsor; contractually limiting the Lender’s rights of financial recourse to the rights in relation to the assets that are wholly or predominately financed or secured by the loan. The other approach is the Lender lends to a special purpose entity established by the Project Sponsor. In the second approach, the benefit is to separate the special purpose entity’s assets and liability from that of the Project Sponsor. In the event of a default, the Lender can only seek recourse on assets that are wholly or predominantly financed or secured by the loan while the Project Sponsor could possibly walk away without any further liability as the Lender takes over the asset.
In considering this type of security, the lender ought to also consider the potential risk of administration of its borrower. During the administration of a company, a financier or other third party is restricted from enforcing its security in certain circumstances by operation of Section 440B Corporations Act 2001 (Cth) (Corporations Act). The restriction applies to most security interests, including mortgage and security agreements and acts as a “Arresto Momentum” charm on the enforcement of security interests during the course of the administration. The operation of the section 440B does not give the administrator a right to deal with assets contrary to a secured party’s assets, however; it is to ensure the administrator has enough time to consider the following arrangement of the administration carefully and fully.
Practically, the delay of enforcement may largely devalue the security. Section 441A of the Corporations Act also provides an exception to the statutory moratorium on the enforcement of certain rights of secured creditors holding a security interest which is perfected under the Personal Property Security Act 2009 (Cth) (PPSA), stating that a secured creditor may enforce its security interest if: 1) the creditor has a perfected security interest over the whole, or substantially the whole, of the property; and 2) the enforcement occurs within the decision period, being 13 days after the appointment of the administrator.
What is a Featherweight Security Deed
In light of the enforcement risk under potential administration, a featherweight security deed may be an option to protect the Lender’s interest in the delay of enforcing the security. A featherweight security is a “feather-like light touch” security interest which is over all assets and undertaking of a company but does not prevent dealings with the featherweight collateral unless or until an administrator is appointed. It usually operates as a floating charge and enforceable only where an administrator is appointed to the company.
The benefits to the Lender include not only minimising the moratorium risk but also helping to reduce collateral pressure and provide more flexibility in structuring. Featherweight security allows Lenders to require minimal collateral, reducing the financial burden on the Project Sponsor. Especially when the Lender is providing limited recourse financing to the Project Sponsor, the Lender’s security can still have a broader coverage with featherweight security. A Lender can benefit from the flexibility of tailoring the security arrangement to the specific needs of the project. This adaptability fosters a collateralised approach, aligning the security structure with the dynamics of the project.
The advantages to the Project Sponsors are noteworthy. the featherweight security will allow the Project Sponsor to continue its normal course of business, giving more room to retain control over its own assets. This can be vital for maintaining liquidity and supporting business activities. The flexibility may also be of importance for businesses that require utilisation of the assets efficiently to support ongoing operations. Finally, featherweight security also promotes a more balanced risk allocation between the Lender and the Project Sponsor by bearing the risk and sharing the success of the project.
It may be preferrable to the Lender to take featherweight security when providing limited recourse financing considering the benefits and advantages in its practice. Under Section 441A Corporation Act, the Lender with security over the whole or substantially the whole of the assets of the company has 13 business days following the appointment of the administrator to exercise its right under the security granted in its favour. If the Lender has featherweight security interest over all of the Project Sponsor’s assets, there is an open window of 13 business days to enforce that interest. The Lender needs to bear in mind that the featherweight security interest must then be registered on the Personal Properties Security Register (PPSR) in time. When the security is registered, it must be described the interest in a way that is clear to all parties that this security is intended to be “featherweight”.
If you require any assistance with advice regarding limited recourse financing or adopting a featherweight security mechanism into your next finance deal, JHK Legal will be happy to assist.
 CORPORATIONS ACT 2001 – SECT 440B