Project Finance

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UNMASKING PROJECT FINANCE: RISK MITIGATION, RISK INDUCEMENT, AND AN INVITATION TO DEVELOPMENT DISASTER?
SHALANDA H. BAKER I. II. III. ABSTRACT.......................................................................................... 274 INTRODUCTION ................................................................................. 275 LA VENTOSA ..................................................................................... 279 A. The La Venta Projects .............................................................. 281 B. Eurus Wind Farm ...................................................................... 282 C. La Mata-La Ventosa Wind Project ......................................... 283 D. The Greening of La Ventosa: Clean energy, Dirty Business ...................................................................................... 284 1. Questionable Acquisition of Indigenous Land ................ 285 2. Disruption of Bird migratory Patterns and Crop Flooding ................................................................................ 287 3. Empty Promises of Employment and Community Development........................................................................ 289 UNDERSTANDING PROJECT FINANCE ............................................ 291 A. Theoretical Underpinnings....................................................... 292 B. Project Finance and DevelopmentThe Mexican Example ...................................................................................... 295 C. Structural Components ............................................................. 300 D. External Rationales for Project Finance................................. 305 E. Internal Rationale for Project Finance ................................... 308 PROJECT FINANCE AS A RISK DIFFUSION MECHANISM............... 310 A. High Debt-to-equity Ratio ....................................................... 311 B. Use of Stand-Alone Project Company .................................... 311 C. Non-Recourse Financing .......................................................... 312 D. Risk Shifting in Project Contracts ........................................... 313
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William H. Hastie Fellow, University of Wisconsin Law School. This article has benefited greatly from feedback and questions received at presentations at the University of Wisconsin Law School, the Earle Mack School of Law, and Vermont Law School. I owe many thanks to andr cummings, Rashmi Dyal-Chand, Carmen G. Gonzalez, Darian Ibrahim, Heinz Klug, Jonathan Lipson, Lahny Silva, and Bill Whitford, who all patiently and willingly commented on earlier drafts of my work. I am particularly grateful for the thoughtful comments and insight of my former colleague, Mitchell Carroll. Finally, Id like to thank the people of La Ventosa for generously allowing me into their lives to learn about their struggles to maintain their dignity and lifeways. I hope this article sheds light on many of the challenges they face. Any errors contained herein are my own.
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1. Commercial Risks................................................................ 314 2. Political Risks....................................................................... 315 VI. PROJECT FINANCE AS A RISK INDUCEMENT MECHANISM .......... 316 A. Low Initial Capital OutlayPassing on the Risk of the How ............................................................................................. 317 B. The Special Purpose EntityObfuscating the Who ............. 320 C. Non-Recourse LoanKeep the Income Stream Flowing .... 321 D. Risk Shifting in Project ContractsPassing the Buck .......... 324 VII. OVERCOMING STRUCTURAL DEFICITS .......................................... 326 A. Eliminate Non-Recourse Loans............................................... 328 B. Lower Debt-to-equity Ratios ................................................... 329 C. Limit Use of Special Purpose Entities .................................... 330 D. Additional Research ................................................................. 332 VIII. CONCLUSION ..................................................................................... 333 I. ABSTRACT
Each year one in every five foreign direct investment dollars in the Global South flows through project finance transactions. These transactions consist of large-scale energy and infrastructure projects, and consistently produce deleterious effects on third parties. Until now, much of the legal scholarship in the infrastructure development field has focused its attention on the complex mechanics of project finance, including understanding the ways in which project promoters utilize project finance to manage commercial and political risks. Much of the human rights and environmental advocacy related to negative development outcomes is limited to seeking ex post facto relief. To date, very few scholars have delved into the intersection between these bodies of scholarship (project finance and human rights), and queried whether project finance transactions, ex ante, have a relationship to the externalities produced in large-scale development projects. This article squarely engages this inquiry, and argues that the risk diffusion mechanisms native to project finance transactions work together to undermine limits on risky behavior on the part of project sponsors and thereby lead to the externalization of risk. To remedy this transactional failure, I recommend that three of the key risk-mitigation features of project finance(1) non-recourse debt, (2) high debt-toequity ratios, and (3) the use of special purpose entitiesbe abrogated in order recalibrate the development calculus and force project sponsors to bear more of the risk of their activities. Ultimately, more rigorous, interdisciplinary, examination of project finance is required to understand fully how this pervasive method of financing infrastructure externalizes many of the costs of development; however, this article provides a useful starting point for the discussion.
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Imagine investing $10 million of equity to create a project company 1 that will engage in the risky business of developing a large-scale infrastructure project in an emerging economy. You will never be held liable for the activities of the subsidiary you create; you will never absorb the environmental, social, and political risks created by the project; and you will never bear the full risk of the projects failure. Your investment, ten million of the one hundred million total financing required for the project, will yield a thirty percent return, 2 and you will continue to invest in similar projects without any of the economic liabilities of such projects ever appearing on your balance sheet. You have discovered the magic of project finance, 3 a significant source of infrastructure development financing in the Global South. 4 It is a boon: You may engage in some of the riskiest transactions on the planet and, in the process, place only your initial investment at risk. Each year the global financial community 5 spends an estimated $1.7 trillion in foreign direct investment-related projects. 6 Nearly a fourth of this investment goes toward energy and infrastructure development using project finance. 7 Such projects run the gamut, from extractive projects
1. A project company is a stand-alone corporate entity formed specifically for the purpose of building a large-scale infrastructure project. 2. See, e.g., Antonio Estache & John Strong, The Rise, the Fall and . . . the Emerging Recovery of Project Finance in Transport 26, (World Bank Institute: Policy Research, Governance, Regulation, and Finance, Working Paper No. 2385, 2000), available at http://www. wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2000/08/14/000094946_0007270535479 5/Rendered/PDF/multi_page.pdf (explaining that a thirty percent equity return is standard for transport infrastructure projects). 3. Harvard Business School Professor Benjamin Esty, a leading project finance scholar, defines project finance as the creation of a legally independent project company financed with non-recourse debt (and equity from one or more sponsors) for the purpose of financing a single purpose, industrial asset. BENJAMIN C. ESTY, MODERN PROJECT FINANCE 25 (2004). In this article, project finance also captures the class of infrastructure projects that are characterized by private investment, their large scale (over $300 million U.S.), and high debt-to-equity ratios. 4. In this article the term Global South encompasses both the geographical designation that refers to those countries that lie south of the Equator and the UNCTAD designation for developing economies. In traditional development parlance, this term generally designates lesser developed countries. See Adam D. Link, Comment, The Perils of Privatization: International Developments and Reform in Water Distribution, 22 PAC. MCGEORGE GLOBAL BUS. & DEV. L.J. 379, 399 n.6 (2010). 5. Here, my use of the term, global financial community, incorporates the United Nations Conference on Trade and Development treatment of foreign direct investment: Investment initiated and primarily carried out by transnational corporations. See United Nations Conference on Trade and Development, Assessing the Impact of the Current Financial and Economic Crisis On Global FDI Flows vii (2009). 6. UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT, UNCTAD HANDBOOK OF STATISTICS 2010 374, U.N. Doc. TD/STAT.35, U.N. Sales No. B.10.II.D.1 (2010) [Hereinafter UNCTAD]. In this article I refer to the 2008 statistics for foreign direct investment, which captures volumes before the onset of the global downturn in liquidity. 7. In An Overview of Project Finance and Infrastructure Finance2009, Professor Benjamin Esty and Senior Researcher Aldo Sesia of the Global Research Group estimate that in 2008 global project finance expenditures reached an all-time high of $409 billion. Harvard Business School case 210-061 at 1 (Harvard Business School Publishing, June 30, 2010).
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and power plants, to oil and gas pipelines, wind farms, and dams. In 2008 the Global South saw approximately $630 billion in foreign direct investment projects. 8 These investments in emerging economies are a part of the larger development narrative constructed by industrialized nations, which began at Bretton Woods 9 and, in its most recent version, calls for private engagement in public projects typically reserved for state actors. 10 In the current iteration of the development discourse, project finance has emerged as an attractive transactional structure, composing approximately one of every five dollars spent on foreign direct investment in the Global South. 11 Project finance, a method of finance wherein borrowers rely on the income stream from a project in order to provide debt service, pervades the development landscape despite its complexity, 12 high transaction costs, 13 and risk of delivering negative environmental and social externalities. 14 The complexity and transaction costs of project finance are well understood and have received a fair amount of scholarly attention. 15 The impacts of infrastructure projects are also well
8. UNCTAD, supra note 6, at 382. 9. The United Nations Monetary and Financial Conference was convened by the forty-four allied nations at Bretton Woods, New Hampshire after World War II. Thereafter, the International Bank for Reconstruction and Development (known as the World Bank) and the International Monetary Fund were created pursuant to the Bretton Woods Treaty. See Sophie Smyth, World Bank Grants in a Changed World Order: How Do We Referee This New Paradigm, 30 U. PA. J. INTL L. 483, 49596 (2008); see also World Bank, What is Bretton Woods, http://external.worldbankimflib.org/Bwf/whatisbw.htm. 10. See discussion infra Part IV. 11. No single database disaggregates project finance-related foreign direct investment data in the Global South; however, an approximation of the percentage of foreign direct investment in the Global South that is attributable to project finance can be made by relying on UNCTAD, supra note 6, which estimates the 2008 foreign direct investment in developing countries, and the Thomson Reuters Global Project Finance Review for the fourth quarter of 2008, which is organized by region and incorporates data from reporting banks in the project finance industry. UNCTAD estimates that $630 billion in foreign direct investment flowed to the Global South. See UNTCAD supra, note 8. According to Thomson Reuters regional data, approximately $113.4 billion went toward project finance developments in the Global South. See Thomson Reuters, Global Project Finance Review Fourth Quarter 2008, available at http://online.thomson reuters.com/DealsIntelligence/ReviewsAndAnalysis/ArchiveQuarterlyReviews (last visited Feb. 7, 2011). Thus, a rough approximation of the amount of foreign direct investment in the Global South properly attributed to project finance is approximately 18%, or about one in every five dollars spent. 12. See Estache & Strong, supra note 2, at 5 (discussing complexity and transaction costs of project finance as compared to traditional financing forms). 13. See ESTY, supra note 3, at 2; BENJAMIN C. ESTY, THE ECONOMIC MOTIVATIONS FOR USING PROJECT FINANCE 9 (2002) (Creating a stand-alone project company takes more time (from 6 to 18 months more) and requires significantly greater transaction costs than financing an asset on an existing balance sheet.). 14. By externality, I mean the infringement of non-contracting parties rights[,] Steven L. Schwarcz, Collapsing Corporate Structures: Resolving the Tension Between Form and Substance, 60 BUS. LAW 109, 121 (2004), and environmental degradation. 15. Stating that project finance transactions are complex is somewhat of an understatement. The extensive documentation coupled with the high level of legal and financial expertise required to complete transactions and constant vigilance with respect to documentation lends itself to significant transaction costs. See Carl S. Bjerre, International Project Finance
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documented and comprise a rich literature. 16 Very few scholars, however, have investigated the relationship between the specific internal legal form of project finance and the externalization of risk that characterizes the form. 17 In this article, I begin to explore this inquiry. This interrogational lens examines the subject, project finance, at its structural interior, and asks whether certain mechanisms native to the financing form consistently produce deleterious effects on third parties who are not parties to these complex transactions. An analysis of the key features of project finance implores an affirmative response. This article answers the call of Carl Bjerre and others 18 who have urged a more exacting review of project finance, the financing and risk mitigation vehicle that, in many cases, makes a significant amount of infrastructure development 19 possible and, my research illustrates, provides to sponsors perverse incentives with respect to risk management. In this article, I argue that the risk diffusion mechanisms native to project finance transactions work together to undermine limits on risky behavior on the part of project sponsors and thereby lead to the externalization of risk. This reality subverts commonly held efficiency
Transactions: Selected Issues Under Revised Article 9, 73 AM. BANKR. L.J. 261, 261 n.3 (1999); Edward D. McCutcheon, Note, Think Globally, (En)act Locally: Promoting Effective National Environmental Regulatory Infrastructures in Developing Nations, 31 CORNELL INTL L.J. 395, 414 n.109 (1998). 16. See, e.g., Kirk Herbertson & David Hunter, Emerging Standards for Sustainable Finance of the Energy Sector, 7 SUSTAINABLE DEV. L. & POLY 4 (2007) (discussing environmental issues related to energy-related projects); Michael B. Likosky, Mitigating Human Rights Risks Under State-Financed and Privatized Infrastructure Projects, 10 IND. J. GLOBAL LEGAL STUD. 65 (2003) (discussing human rights risks associated with infrastructure development); Matthew F. Smith & Naing Htoo, Energy Security: Security For Whom?, 11 YALE HUM. RTS. & DEV. L.J. 217 (2008) (discussing human rights impact of natural gas development in Burma); Abby Rubinson, Note, Regional Projects Require Regional Planning: Human Rights Impacts Arising from Infrastructure Projects, 28 MICH. J. INTL L. 175 (2006) (discussing human and environmental impacts of Rio Madeira dam projects in Brazil). A full analysis of the various methodologies deployed in the development context to measure social harm exceeds the scope of this article. My analysis instead aims to focus attention on the transactional components of project finance and their specific connection to such externalities, however measured. The economic question of how environmental and social externalities are measured against the backdrop of infrastructure production in the development context therefore remains a live issue here. 17. There are a few exceptions. See generally Carl S. Bjerre, Project Finance, Securitization and Consensuality, 12 DUKE J. COMP. & INTL L. J. 411 (2002); Lissa Lamkin Broome, The Social Impact of Project Finance, 12 DUKE J. COMP. & INTL L. J. 439 (2002); Wendy N. Duong, Partnerships with MonarchsTwo Case Studies: Case Two Partnerships with Monarchs in the Development of Energy Resources: Dissecting an Independent Power Project and Re-Evaluating the Role of Multilateral and Project Financing in the International Energy Sector, 26 U. PA. J. INTL ECON. L. 69 (2005). 18. See Bjerre, supra note 17, at 41112 (seeking to avoid dwelling almost exclusively on doctrinal and practical questions such as how the transactions work and how they are negotiated and calling for fresh and interdisciplinary attention to the negative effects of project finance on non-consenting third parties). 19. In this article infrastructure development refers to the ambit of project finance financed projects, including, but not limited to, toll roads; extractive projects such as oil or mining; energy production facilities, such as wind or gas; and dams. Although many of the projects may not provide infrastructure in the physical sense, the rationale supporting their development is generally the same, to bring economic prosperity to a region.
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and risk-management principles that are deeply rooted in law and economics and, more fundamentally, undermines basic notions of social justice and fairness. Part III begins with a discussion of wind development currently underway in Oaxaca, Mexico, and illustrates that the negative externalities relating to project finance emerge even with respect to carbon-limiting projects with stated green objectives. Following this discussion, Part IV provides an historical overview of project finance generally and then discusses the various rationales employed to justify its use. Part V explores the following key risk diffusion methods implemented in project finance and their respective rationales: (1) high debt-to-equity ratio; (2) use of a special purpose entity; (3) non-recourse loan; and (4) project contracts. The technical aspects of each of these selected riskmitigation mechanisms are then addressed in short form, and their underlying rationales, including potential to alleviate significant project risk for sponsors and developers, are explored. The discussion at Part VI begins the process of evaluating each riskdiffusion mechanism vis--vis infrastructure development. Here, I argue that the mechanisms fail to address certain risks inherent at the outset and create an environment where certain risks go unchecked and shift onto those who cannot contractually avoid them. 20 In Part VII, I offer a policy solution to the structural deficits of project finance transactions. I suggest three possible avenues to overcome those deficits: (1) eliminating the non-recourse loan, (2) lowering the debt-toequity ratios that characterize project finance transactions, and (3) limiting the use of special purpose entities as project companies. I note that, normatively, a reworking or outright rejection of the project finance model would be preferable, but project finance serves such a critical function in the discursive production of the development narrative that small fixes on a transaction-by-transaction level may be the only realistic solutions. 21 This section also highlights areas for further research and advocates for a disruption of the assumption of project finances neutrality. In light of the foregoing assertions, this article aims to reinvigorate the academic debate regarding limited liability, 22 and presses
20. See Daniel D. Bradlow, Private Complainants and International Organizations: A Comparative Study of the Independent Inspection Mechanisms in International Financial Institutions, 36 GEO. J. INTL L. 403, 406 (2005) (pointing out that one group that historically has not been able to hold international organizations accountable is non-state actors who are adversely affected by the actions of an international organization but who have no contractual relationships with it). 21. See, e.g., Heather Hughes, Counterintuitive Thoughts on Legal Scholarship and Secured Transactions, 55 BUFF. L. REV. 863, 884 (2007) (noting that many law reforms rooted in equality and fairness are viewed as infeasible). 22. See Lynn LoPucki, The Death of Liability, 106 YALE L.J. 1, 3 (1996) (engaging debate on
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colleagues across disciplines to re-engage the inquiry into limiting the liability of private actors in the development context, specifically vis--vis the complex contractual framework of project finance. A cursory explanation of project finance provides the necessary contextual lens through which the preliminary analysis takes place. I begin with a familiar development trope: The disenfranchisement and effective displacement of indigenous people. III. LA VENTOSA As I rode the dusty Oaxacan highway bound for a meeting with indigenous groups in the picturesque mountain town of San Miguel del Puerto to discuss the devastation wrought by several mega-development projects in the region, I reflected on the events of the previous four months. I, a corporate lawyer, had landed in the city of Oaxaca, Mexico, 23 on a one-way ticket. My goal? To take a break from my life as a corporate and project finance attorney, learn about a new culture and, perhaps, do a bit of good in the process. Admittedly, this was a selfindulgent mission, but I found myself immediately captivated by Oaxacas cultural and biological diversity, its historical importance for various social justice movements, 24 and its current situation as the site of an epic struggle between a group of indigenous subsistence farmers and several wind projects developed in the Juchitn region of Oaxaca. 25 To understand the controversy surrounding the wind projects, however, one must first understand Oaxaca, the second poorest state in Mexico. 26 Oaxacas physical beauty is arresting, but the state is also known throughout Mexico for its deep cultural significance as the ancestral home to over fourteen indigenous groups who speak no fewer than the same number of unique indigenous languages. 27 The region resonates with the vibration of this history. The capital of the state, Oaxaca City, sits in a valley surrounded by colorful mountains and once served as the
the limited liability issue). 23. Oaxaca is located in the southern region of Mexico, sandwiched among the Mexican states of Guerrero and Chiapas to the west and east, respectively, and Puebla and Veracruz to the north. 24. In 2006 teachers in Oaxaca initiated a pay-related strike that led to the galvanization of the political left and the call for the resignation of the governor of Oaxaca. Oaxaca Teachers Strike Gains Momentum (National Public Radio broadcast Aug. 24, 2006), available at 2006 WLNR 22949361. The tension continued for six months and led to at least five deaths in the state. Sam Enriquez, Mexico: Oaxaca Teachers To End Strike; Unrest Remains, MIAMI HERALD, Oct. 21, 2006, available at 2006 WLNR 18295757. 25. See Zach Dyer, Clean Energy Plays Dirty in Oaxaca, NORTH AMERICAN CONGRESS ON LATIN AMERICA, Mar. 23, 2009, https://nacla.org/node/5638. 26. Tom Harmon, Oaxaca Where Mexico Shows Its Many Faces, ALBUQUERQUE JOURNAL, May 14, 2000, 2000 WLNR 2223705. 27. Lynn Stephen, Negotiating Global, National, and Local Rights in a Zapotec Community, 28 POL. & LEGAL ANTHROPOLOGY REV. 133 (2005).
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capital of the Zapotec empire. 28 From Oaxaca City one can travel through the Sierra Norte or Sur to the coastal region of Oaxaca, which boasts an Afro-Mexican population and abundant natural resources such as wind, oil, and natural gas. 29 When travelling along the Pacific coast through the isthmus region of Oaxaca, El Istmo de Tehuantapec (El Istmo), one is immediately struck by several distinct features. On the whole, the region is poorer than the rest of the state; however, the people of the isthmus, los istmeos, retain a defiant pride for the culture and abundant natural resources of the region. Notably, it is home to Mexicos petrofuel industry and has been identified by the federal government as the future location for various mega-development projects along the coast. 30 The wind in El Istmo also blows constantly, and by some measures, it is the windiest region of the world. 31 In fact, the region is nicknamed La Ventosa, or the windy place. Ah, the wind. This seemingly benign resource, and its abundance in El Istmo, an impoverished sector of the second poorest state in a developing country, sparked a controversy that has all of the elements of a classic imperial development drama. The story begins in Europe and the United States, regions that are no strangers to the complexities of Latin America. A group of primarily Spanish and French companies, relying on studies that confirmed the economic viability of developing wind projects in El Istmo, among them a definitive study conducted by the U.S. National Renewable Energy Laboratory, 32 moved quickly to identify a strategy that would effectively divide El Istmo into development parcels to serve as individual sites for wind projects. The companies, including Spains Acciona Energa, S.A., and EDF Energies Nouvelles S.A. of France, partitioned the La Ventosa
28. Harmon, supra note 26. 29. See Robert J. Cottrol, The Long Lingering Shadow: Law, Liberalism, and Cultures of Racial Hierarchy and Identity in the Americas, 76 TUL. L. REV. 11, 28 (2001) (discussing the Afro-Mexican population on the west coast of Oaxaca); Another Piece in the Puzzle: Plan Puebla Panama; Mexicos Latest Assault on the Environment and Indigenous Culture, CLAMOR MAGAZINE, Nov. 1, 2001, 2001 WLNR 9801983 (discussing the impact of Pemex refinery in the Isthmus). 30. See, e.g., Mara Eugenia Padua, Mexicos Part in the Neoliberal Project, 8 U.C. DAVIS J. INTL L. & POLY 1, 28 (2002) (discussing the Puebla-Panama Plan, which features extensive infrastructure projects in Central America, including the modernization of the railroad in the Isthmus of Tehuantepec). 31. See Posting of Tara Brian, Center for Strategic & International Studies: Sinon Chairs Blog, Mexicos Wind Industry Picks Up, Yet Obstacles Prevent This Breeze From Becoming A Gale, http://csis.org/blog/mexico%E2%80%99s-wind-industry-picks-yet-obstacles-prevent-bree ze-becoming-gale (Oct. 21, 2010) (noting that the Isthmus of Tehuantepec is considered one of the best sites for wind development in the world). 32. The study conducted by the U.S.-based National Renewable Energy Laboratory estimates that Mexico has the potential to install and use approximately 40,000 MW of wind energy. U.S. DEPT OF ENERGY, NATIONAL RENEWABLE ENERGY LABORATORY, WIND ENERGY RESOURCE ATLAS OF OAXACA (2003), http://pdf.usaid.gov/pdf_docs/PNADE741.pdf.
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region into no fewer than fourteen separate wind projects, 33 with an estimated overall investment slated to reach over five billion U.S. dollars. 34 Many of the wind developments have thus far generated intense struggles between the developers and indigenous people living in the area. The three primary developments highlighted below provide a strong sampling of the way the wind has developed in Oaxaca as a commodity to be captured, exploited, and exported. A. The La Venta Projects With strong technical support from the World Bank, the Mexican government developed the first wind project in Oaxaca, beginning with a relatively small test project, called La Venta I. 35 The project formed the first part of a series of government-led developments named La Venta I, La Venta II, 36 and La Venta III. 37 The La Venta projects were developed
33. The Global Wind Energy Council estimates that Mexico currently has 202.29 MW of wind power generation currently installed, and 568.35 MW under construction, with the vast majority of the developments occurring in the Isthmus region of Oaxaca. Global Wind Energy Council, Mexico, http://www.gwec.net/index.php?id=119 (last visited May 20, 2011). The Center for Strategic and International Studies also estimates that there are at least 28 wind projects in various stages of development in Mexico. Center for Strategic and International Studies, supra note 31. 34. Press Release, Inter-American Development Bank, IDB to Finance Historic Expansion of Wind Power in Mexico, (Dec. 15, 2009), http://www.iadb.org/NEWS/detail.cfm?Language =En&artType=PR&artid=6118&id=6118. 35. La Venta I, a 2 MW project, became operational in 1994. See Inter-American Development Bank, Environmental and Social Strategy, http://idbdocs.iadb.org/wsdocs/get document.aspx?docnum=2025671 (last visited May 20, 2011). For a sense of scale, an average U.S. home uses approximately 10,000 kilowatt-hours of electricity per year. One megawatt is equal to 1000 kilowatts. Kim Castleberry, Looking to the Wind for Energy Colorado is in Top 20 for Potential; Hurdles Remain, BOULDER DAILY CAMERA, May 17, 2005, 2005 WLNR 7943206. 36. La Venta II, a 2,000 acre, 83.3 MW project developed by the Mexican Federal Electricity Commission (CFE), an entity owned by the Mexican government, was constructed by Spanish companies Gamesa Elica and Iberdrola Renovables, and went on line in January of 2007. See Press Release, Iberdrola, Iberdrola Ingeniera Awarded $2 Billion Contract to Build Combined Power Plant in Venezuela (July 29, 2009) http://www.iberdrola.es/webibd/corporativa/iberdrola? IDPAG=ENMODULOPRENSA&URLPAG=/gc/prod/en/comunicacion/notasprensa/090729_ NP_02_IING_CCVenezuela.html (noting that the company previously constructed the La Venta II wind farm); UNITED NATIONS FRAMEWORK COMMISSION ON CLIMATE CHANGE, LA VENTA II 3RD MONITORING REPORT 2 (Feb. 20, 2011), available at http://cdm.unfccc.int/User Management/FileStorage/EVG6YORKTUAC9XMQL0N1F8D3PZS2JH (stating that the project was commissioned on January 5, 2007). 37. La Venta III, a 102.85 MW project, was scheduled to go on line in November of 2010, and is expected to serve 200,000 people and avoid the emission of 160,000 tons of carbon dioxide. Press Release, Iberdola, Iberdrola Renovables Wins Contract for 103 MW Wind Farm in Mexico (Apr. 3, 2009), http://www.iberdrola.es/webibd/corporativa/iberdrola?IDPAG= ENMODULOPRENSA&URLPAG=/gc/prod/en/comunicacion/notasprensa/090304_NP_01_IR parque_Mexico.html. Iberdrola Renovables is contracted to provide the construction expertise for the project and promises to supply energy to CFE under a 20-year contract. Id. The project is the first Mexican private wind independent power producer project. INTERNATIONAL FINANCE CORPORATION, CLEAN TECHNOLOGY FUND PROJECT PROPOSAL FOR MEXICO: PRIVATE SECTOR WIND DEVELOPMENT (CURRENT INFORMATION DOCUMENT) 48 (June 29, 2009), available at http://www.climateinvestmentfunds.org/cif/sites/climateinvestmentfunds.org/files/ Current_Information_Ducument_Mexico_Private_Sector_Wind.pdf. The 121 wind turbines will be built by Gamesa Elica, a Spanish company. Iberdrola Engineering and Construction, La
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to give Mexico the opportunity to gain experience with wind development while maintaining control of the market. 38 The government-led La Venta projects are noted here because they provided an early template for private investors determining whether to enter the risky environment of developing wind farms in Mexico. The success of the Mexican governments projects paved the way for market entry by Acciona Energa of Spain, who, through a subsidiary, developed the largest wind project ever seen in Latin America and the Caribbean. B. Eurus Wind Farm The Eurus wind farm is by far the largest wind power project ever built in Latin America and the Caribbean. 39 The 250.5 megawatt (MW) project is being developed by Acciona Energa Mxico (AEM), a wholly owned subsidiary of Acciona Energa of Spain, through a special purpose limited liability company, Eurus S.A.P.I. de C.V. 40 The project consists of 167 turbines that were installed in November of 2009, nearly eight months before the $525 million project 41 reached financial closing in June of 2010. 42 A consortium of ten financial institutions, including the Inter-American Development Bank (the IDB), the International Finance Corporation (the IFC, the commercial lending arm of the World Bank), Mexican companies, and commercial banks, will provide the long-term debt financing for the project. 43 Records indicate that the debt-to-equity ratio of the project ranges from seventy to thirty (70/30), to sixty-five to thirty-five (65/35), 44 which means that the initial project developers contributed about 30% to 35% of the project cost, while the lenders provided the remaining amounts. On the clean energy front, the project also includes the sale of United Nations Certified Emissions Reductions (CERs) credits 45 in its plan,
Venta III Wind Farm (Mexico), http://www.iberdrolaingenieria.com/ibding/proyectos.do?op= det&id=30&despliega=3. 38. See TED KENNEDY CLIMATE CHANGE TEAM, WORLD BANK, RETOOLKIT CASE STUDY MXICO: LARGE SCALE RENEWABLE ENERGY DEVELOPMENT PROJECT, available at http://siteresources.worldbank.org/EXTRENENERGYTK/Resources/51382461238175210723/M exico0Large0S1Development0Project0.pdf. 39. Inter-American Development Bank, supra note 34. By one estimate the Eurus farm will generate enough electricity for a city of 500,000 people. See North American Congress on Latin America, supra note 25. 40. See Inter-American Development Bank, Project Abstract (June 10, 2009), http://idb docs.iadb.org/wsdocs/getdocument.aspx?docnum=2030700 (last visited Jan. 19, 2011). 41. See id. 42. Inter-American Development Bank, supra note 34. 43. See Press Release, Acciona Energy, Ten Entities Finance ACCIONAs Eurus Windpark in Mexico with USD375m (Nov 6, 2010), http://www.acciona.com/news/ten-entities-financeaccionas-eurus-windpark-in-mexico-with-usd375m-. 44. Banks provided approximately $375 million of debt for the $525 million project. See Inter-American Development Bank, supra note 40 (discussing estimated project cost of $525 million); Acciona Energy, supra note 43. 45. The United Nations (UN) Clean Development Mechanism program allows a private
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and it is estimated that the project shall benefit from the sale of credits for a total of 600,000 tons of avoided carbon dioxide emissions per year. 46 In general, according to a bank official who declined to submit any further documentation related to the transaction, the project is a fairly standard project finance structure with typical security on all project related assets. 47 C. La Mata-La Ventosa Wind Project The third project, named the La Mata-La Ventosa wind project, consists of twenty-seven 2.5 MW wind turbine generators made by Clipper Windpower Plc (Clipper) 48 for a total of 67.5 MW total capacity. A special purpose limited liability company, Elctrica del Valle de Mxico S. de R.L. de C.V. (EVM), a subsidiary of the French power company, EDF Energies Nouvelles (EDF) owns and developed the project. 49 The project reached its financial closing in late 2010 50 and cost an estimated $200 million U.S. dollars. 51 The project is being financed in large part by the IDB and the International Finance Corporation (the IFC), who together will provide 585 million Mexican pesos of debt, and the U.S. Export-Import Bank, who will also provide approximately $81 million U.S. dollars. 52 A subordinate lender will provide $15 million U.S. dollars of subordinated debt. 53 The debt-to-equity ratio of the project is estimated at between seventy to thirty (70/30) and eighty to twenty (80/20), depending on the currency used for the calculations. 54 The collateral used for the project consisted of project assets, and the debt provided was non-recourse as to the assets of the sponsors, with a small of amount of funding provided on a recourse basis that is expected to
developer to develop an emission-reduction project in a developing country and, based on a set of criteria designated by the UN, generate Certified Emissions Reductions that are then sold on the market. The purchasers of the credits are countries that have agreed to reduce carbon dioxide emissions to meet agreed-upon targets. See United Nations Framework Convention on Climate Change, About CDM, http://cdm.unfccc.int/about/index.html (last visited Mar.25, 2011); Inter-American Development Bank, supra note 34. 46. Id. 47. E-mail from Rachel Robboy, Principal Investment Officer, Infrastructure Division, InterAmerican Development Bank, to author (Jan. 24, 2011, 15:21 CST) (on file with author). 48. Clipper Windpower Plc is a wind energy technology developer. Its primary offices are located in the United Kingdom and California. Press Release, Clipper Windpower, Ex-Im Bank Approves Debt Financing for Clippers Liberty Wind Turbines (Nov. 26, 2009), http://www.clipperwind.com/pr_112609.html. 49. Id. 50. Press Release, International Finance Corporation, IFC Helps Finance Mexican WindPower Project to Increase Renewable-Energy Sources (Dec. 14, 2010), http://www.ifc.org/ifcext/ media.nsf/content/SelectedPressRelease?OpenDocument&UNID=BA4A366AE5794447852577 F9006467BC. 51. Renewables, Project Finance, Jan. 2010. 52. E-mail from Jefferson Boyd Easum, official, Inter-American Development Bank, to author (Jan. 13, 2011, 15:53 CST) (on file with author). 53. Id. 54. Id.
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convert to non-recourse debt quickly. 55 The project is also working to obtain United Nations CERs credits, and is estimated to receive credits for up to 168,000 tons of avoided carbon dioxide emissions per year. 56 As for management of the project, Clipper is expected to operate the plant for five years before transferring the plant to enXco, a subsidiary of EDF. 57 In general, the foregoing projects and others in the region have been met with substantial resistance from the local community. In several wellpublicized instances, such as with Accionas Eurus project, construction has been halted altogether. 58 Despite such rocky beginnings, the successful financial closings of the Eurus and La Ventosa-La Mata projects all but guarantee that private investors will continue to invest in Oaxacas profitable wind market. 59 The wind always blows in Oaxaca, and the region provides solid partners to purchase the energy produced. Moreover, the tried and true method of structuring the transactions poses few limitations on sponsors abilities to displace key risks upon third parties. D. The Greening of La Ventosa: Clean energy, Dirty Business 60 In the planning process for the foregoing developments, several wrinkles became apparent. As an initial matter, Mexican law forbids the private sale of energy unless such private production is for self-generation for particular entities, or for export to other countries. 61 The selfgeneration, or autogeneration, legal framework allows private wind developers to sell power to commercial and industrial groups in Mexico as off-takers, as long as such off-taker also becomes a shareholder in the
55. Id. 56. Inter-American Development Bank, supra note 34. 57. E-mail from Jefferson Boyd Easum, supra note 52. See also enXco, Corporate Structure, http://www.enxco.com/about/corporate_structure/ (last visited May 20, 2011). 58. Construction at the Eurus project was halted at least six times, with members of the community posting signs indicating that La Venta belongs to the ejido. Chris Hawley, Cleanenergy Windmills A Dirty Business For Farmers in Mexico, USA TODAY, June 17, 2009, http:// www.usatoday.com/money/industries/energy/environment/2009-06-16-mexico-wind-power_N. htm. 59. See Presidential Pride?, PROJECT FINANCE AND INFRASTRUCTURE FINANCE, Nov. 2010, available at http://www.projectfinancemagazine.com/Article/2719427/Presidential-pride.html (noting that the closing of Eurus, La Mata-La Ventosa, and a third project generated momentum that will allow subsequent investors to rely primarily on commercial banks to provide project financing). 60. See Hawley, supra note 58 (quoting attorney Claudia Vera of Tepeyac Human Rights Center in Oaxaca who stated, [i]ts clean energy but dirty business, in discussing the private wind development underway in Oaxaca). 61. As a general rule, Mexican law forbids the private sale of energy to the public. The auto-abastiemiento (or self-generation) law, amended the Electric Energy Public Service Law in 1992 and provides that the private sector may participate in the generation of energy if such production goes to a particular entity or individual, through generation from an independent power producer (IPP), or for export to other country. See Global Wind Energy Council, supra note 33.
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project. 62 Being entrepreneurial, the private developers worked closely with the Mexican government to determine appropriate buyers of the energy produced. Enter Wal-Mart, a company with a complex history of its own, who is aiming to green its Mexico operations, and Cemex, the Mexican cement manufacturer. 63 Wal-Mart de Mxico, a subsidiary of the American retail giant, Wal-Mart, 64 resolved the power purchaser problem in the La Ventosa-La Mata wind project by utilizing four of its subsidiaries to purchase the electricity generated from the project under fifteen-year power purchase agreements. 65 Cemex, a global supplier of cement and concrete, is an equity partner in the Eurus project, and has entered into a twenty-year power purchase agreement to purchase its power from the Eurus wind farm. 66 According to Cemex press releases, the Eurus project will provide 25% of the power for its operations. 67 The companies proceeded with the planned developments after meeting the requirements of Mexicos autogeneration legal framework, but certain issues remained with respect to acquiring the land required to build the wind turbines, the environment, and the disruptive effects of the projects. 1. Questionable Acquisition of Indigenous Land The public relations material provided by the IDB describes the landacquisition process as straightforward:
The land on which the turbines of both projects are located has been leased from local ejidos, a traditional Mexican system of communal land ownership that is widespread in the countrys rural areas. These projects will generate jobs and a steady flow of income from leases for these communities. 68
Of course, the actual story is more complex. The land subject to the parceling happens to be occupied by indigenous Oaxacans who speak little Spanish and rely on the land for subsistence farming. 69 The companies, undeterred, proceeded to enter
62. See International Finance Corporation, supra note 37. 63. Inter-American Development Bank, supra note 34 (noting that Wal-Mart aims to use 100% renewable energy in its Mexico operations). 64. See Corporate Information, Wal-Mart de Mexico S.A.B. de C.V., http://www.corp orateinformation.com/Company-Snapshot.aspx?cusip=C484P8980 (last visited May 20, 2011) (Wal-Mart Store, Inc., principal shareholder of Wal-Mart de Mexico). 65. Inter-American Development Bank, supra note 34; International Finance Corporation, EDF La Ventosa, http://www.ifc.org/ifcext/spiwebsite1.nsf/1ca07340e47a35cd85256efb00700 cee/81ACEB3C99869A77852576BA000E32E3. 66. Inter-American Development Bank, supra note 34. 67. CEMEX, Cemex announces completion of EURUS wind farm construction, Nov. 23, 2009, http://www.cemex.com/qr/mc_pr_112309.asp. 68. Inter-American Development Bank, supra note 34. 69. The indigenous communities in El Istmo speak Zapotec, an indigenous language. See North American Congress on Latin America, supra note 25 (stating that not everyone in the
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into various long-term land leases with individual farmers that provided for the construction of the turbines and the right to enter the land for the development, construction, and installation of the wind turbines, including any necessary infrastructure. 70 Although the specific terms of each contract are not public information, a contract provided by an indigenous rights organization and in connection with a different project indicates that one developer obtained land at the bargain price of $120 per year, per hectare, for twenty-five years, renewable at the option of the lessee, and terminable only at the discretion of the lessee, which is consistent with other accounts of the land leases in the area. 71 In addition, amounts paid to other farmers are said to be ten to twenty times less than amounts offered to American farmers for similar uses. 72 Moreover, although the ejido property ownership structure provides for communal ownership of land and limited alienation, the land leases were as between individuals and the project developers, not the community and the developers. 73 In the La Mata-La Ventosa project, the project company was not even the entity that entered into the land leases. Instead, EVM and EDF relied on affiliates to perform this role. 74
region knows Spanish in addition to Zapotec and, according to Javier Balderas, the director of the Tepeyac Center for Human Rights in Oaxaca, representatives of the Eurus project used local leaders who used their position in the community and understanding of the Zapotec language to get landowners to sign [land] contracts). 70. INTER-AMERICAN DEVELOPMENT BANK, MEXICO EURUS WIND PROJECT (ME-L1068) ENVIRONMENTAL AND SOCIAL MANAGEMENT REPORT (ESMR) 2 (Nov. 20, 2009), available at http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=2150998. 71. See Contrato de Arrendamiento, Eoliatec del Istmo, S.A. de C.V.-Vicente Snchez Orozco, April 30, 2004 (on file with author). The North American Congress on Latin America (NACLA) states that some of the leases are at rates of less than $50 per month for locals with turbines on their land and less for those without turbines. NACLA also states that some farmers have received additional, one-time signing bonuses of $650 to entice them to sign. See NORTH AMERICAN CONGRESS ON LATIN AMERICA, supra note 25. Some estimates are even lower. The Latin American Press interviewed one farmer whose lands were rented to a developer at $15 per year, per hectare. Karen Trejo, Wind Parks Take Over Indigenous Lands, LATIN AMERICA PRESS, Aug. 14, 2008, http://www.lapress.org/articles.asp?art=5683. 72. See Diego Cevallos, Farmers and Scientists See Risks in Wind Energy, TIERRAMRICA, Feb. 26, 2011, http://www.tierramerica.info/nota.php?lang=eng&idnews=85. 73. Over the past two decades, the ejido land ownership structure has undergone significant reform. In 1992, the Mexican government initiated land reform that allowed previously inalienable ejidal property to be transferred, leased, collateralized, and sold to private interests. JENNIFER BROWN, EJIDOS AND COMUNIDADES IN OAXACA MEXICO: IMPACT OF THE 1992 REFORMS 1 (Rural Development Institute, 2004). There is a genuine legal issue regarding whether the land subject to the various wind project leases was subject to the ejido structure or private ownership, because although the 1992 agrarian reform permits a conversion from communal ejido property ownership to private ownership, the privatization process is extensive, requires an assembly vote of all of the ejido members, and gives members of the ejido right of first refusal for a transfer of interests. See id. at 20. Depending on the characterization of the auto-renew leases, the agreements could be viewed as extra-legal. See id. at 23. For an in-depth discussion of the ejido structure, see id. and Carmen G. Gonzalez, Deconstructing Comparative Advantage: Environmental Justice, Indigenous Peoples, and the Mexican Neoliberal Economic Reforms, 32 U. PA. J. INTL L., 10810. A detailed analysis of this issue is beyond the scope of this article. 74. E-mail from Jefferson Boyd Easum, supra note 52.
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Advocates closer to the land rights issues also state that the developers accessed the leased land through deceptive contracts and by misleading the local communities. 75 Further, they contend, the subsistence farmers who rely on the land for the production of crops have stated that the turbines have significantly limited the remaining arable portion of their land. 76 In general the transactions were complex, involving a dizzying array of calculations relating to land use and turbine output. Moreover, some of the farmers claim that the documents were not presented in their native language and they never received copies of their documents, making it even more difficult to pursue contractual claims against developers. 77 2. Disruption of Bird Migratory Patterns and Crop Flooding Despite the recognition by the U.N. of the projects potential to provide widespread global benefits by the reduction of carbon emissions, there are significant environmental concerns. As one of the windiest places on earth, El Istmo, the narrow strip of land linking the Pacific and Atlantic oceans, serves as a critical migratory path for six million birds, including thirty-two endangered species and nine species that are indigenous to the region. 78 Farmers and a group of engineers from the Technical Institute of Tehuantepec have also raised significant concerns regarding the impact the 200 tons of concrete per wind turbine will have on the local watershed. 79 Such concerns include crop flooding and the eventual depletion of the water table. 80 Even if one assumes that the lease prices negotiated by the project developers adequately compensate farmers for the use of their land, such leases do not contemplate the longterm social and environmental effects of flooding and eventual displacement resulting from the wind farms 81 Such incomplete contracts 82
75. Center for Strategic and International Studies, supra note 31. 76. NORTH AMERICAN CONGRESS ON LATIN AMERICA, supra note 25 (stating that in the La Venta II development [c]ommunity members signed contracts with La Venta II on the premise that they would be able to continue farming in the spaces between turbines. Out of the projects 800 hectares, 400 was set aside for farming). 77. See Draft Complaint of lvaro Martnez Snchez, C. Juez de lo Civil en Juchitn de Zaragoza, Oaxaca (April 25, 2008) (on file with author). 78. See Tierramrica, supra note 72; INTER-AMERICAN DEVELOPMENT BANK, supra note 70, at 78. 79. See Center for Strategic and International Studies, supra note 31. 80. NORTH AMERICAN CONGRESS ON LATIN AMERICA, supra note 25. 81. One account of one wind development project in the Isthmus estimates that 1,200 tons of concrete is needed per tower, and gravel roads fifty feet across were built to support generators required for construction. One farmer now has two roads cutting through his [sixteen] acres of pasture, and says part of his land is unusable because of dust and blocked irrigation lines. He cut his herd from [thirty] cows to [ten]. Living Off the Wind, THE ARIZONA REPUBLIC, June 24, 2009, 2009 WLNR 15694180. 82. Many project finance transactions run the risk of producing incomplete contracts, even as between sophisticated parties with equal bargaining power. See Stephen J. Choi & G. Mitu Gulati, Contract as Statute, 104 MICH. LAW REV. 1129, 1159 (2006) (noting that highly
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raise serious concerns about the environmental sustainability of these projects, which could lead to the uprooting of indigenous communities who have resided in the La Ventosa area for hundreds of years. 83 By contrast, the IFC categorizes the La Mata-La Ventosa project as a Category B project under the IFCs Environmental and Social Review Procedure 84 because it shall have a small total physical footprint from platforms, roads, substation and ancillary facilities (approximately sixteen hectares) and, according to the IFC, limited environmental and social impacts that can be readily addressed through accepted good engineering practices. 85 The IFC further avoids a more fulsome discussion of the environmental impacts of the project by stating that:
The Project footprint does not directly impact or touch any protected area/habitat and will physically affect less than 0.5% of total ejido lands in La Mata and La Ventosa. Based on migration patterns, the space above the wind farms may at times constitute natural habitat critical to migratory species, however given that there are only [twenty-seven] turbines, risks and impacts to birds and bats are not considered significant. 86
This discussion ignores an obvious feature of the wind development currently under way in El Istmo. The development is extensive. Indeed, no fewer than fourteen separate projects are currently identified for potential construction in the region. Certainly one project, such as La Mata-La Ventosa, might not have a significant impact on the migratory patterns in the region, but taken as a whole, the overall development could have far-reaching impacts not only in El Istmo, but also in the global ecosystem. 87 The IFC material hints at as much, noting that certain coastal portions of El Istmo and the Sierra Tolistoque mountain range
negotiated agreements between sophisticated parties have long been recognized as running the risk of being incomplete). See also ESTY, supra note 3, at 10. When the parties to the agreement are of arguably unequal bargaining power and there are serious information asymmetries, such as here, incomplete contracts could further aggravate the harm suffered by the party in the weaker bargaining position. 83. See, e.g., Lisa J. Laplante & Suzanne A. Spears, Out of the Conflict Zone: The Case for Community Consent Processes in the Extractive Sector, 11 YALE HUM. RTS. & DEV. L.J. 69, 77 (2008) (noting that in the extractive industry, expansion is concentrated in areas where communities are marginalized on multiple levels and often the developments are located within communities of indigenous people or farmers who have lived in in [sic] the same remote areas for many centuries). 84. International Finance Corporation, EDF La Ventosa, supra note 65. According to the IFCs Policy on Social & Environmental Sustainability, a Category B project is one with potential limited adverse social or environmental impacts that are few in number, generally sitespecific, largely reversible and readily addressed through mitigation measures. International Finance Corporation, Environmental and Social Standards, http://www.ifc.org/ifcext/sustain ability.nsf/Content/EnvSocStandards (accessed by clicking Policy on Social and Environmental Sustainability). 85. International Finance Corporation, supra note 65. 86. Id. 87. See Cevallos, supra note 72.
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form part of a bird migration corridor that connects the Atlantic and Pacific Coasts. The IDB also notes that the [p]otential cumulative impacts of those wind farms [adjacent to the Eurus wind farm] on migratory birds, and their significance at the species level is currently unknown. 88 The IFC materials justify the La Mata-La Ventosa project, however, by noting that, according to results of bird monitoring activities carried out in 2007 and 2008, the Projects site is not located within a high bird traffic zone in either the fall or spring migratory seasons. 89 3. Empty Promises of Employment and Community Development On social issues, the IFC, the commercial lending arm for the World Bank, an agency created solely for the elimination of global poverty, 90 is even more cavalier. In discussing the La Mata-La Ventosa project, the agency states that the wind project entails no involuntary physical resettlement and only marginal economic displacement. All land where turbines, access roads and the substation are located was formerly agricultural land and/or existing roads, and is being leased by [EVM] at market rates on a voluntary basis. 91 This perspective does not comport with the reality voiced by many istmeos materially affected by the La Mata-La Ventosa project and other projects that mirror its form. The residents on whose land these projects will be located are experiencing a profound and fundamental shift in their lifeways. These residents have a deep spiritual and cultural attachment to their ancestral home, 92 and have relied on the land for centuries, raising limited crops for survival. For many, this way of life is in jeopardy. The spiritual, cultural, and historical fabric of communities has been permanently ruptured. This is not insignificant. With respect to economic development, the stated aims of the La
88. INTER-AMERICAN DEVELOPMENT BANK, supra note 70, at 11. 89. International Finance Corporation, supra note 65. 90. See World Bank, About Us, http://web.worldbank.org/WBSITE/EXTERNAL/EXT ABOUTUS/0,,pagePK:50004410~piPK:36602~theSitePK:29708,00.html (last visited May 20, 2011) (explaining that the mission of the World Bank is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources, sharing knowledge, building capacity and forging partnerships in the public and private sectors.). 91. International Finance Corporation, supra note 65. In light of the IFCs comprehensive guidelines concerning sustainable development, this attitude is alarming, but is consistent with other findings that, due to internal and external pressures, officials at multilateral development institutions tend to minimize the environmental and social affects of projects. See Rachel Bowen, Note, Walking the Talk: The Effectiveness of Environmental Commitments Made by Multilateral Development Banks, 22 GEO. INTL ENVTL. L. REV. 731, 74243 (2010); e.g., International FINANCE CORPORATION, INTERNATIONAL FINANCE CORPORATIONS POLICY ON SOCIAL & ENVIRONMENTAL SUSTAINABILITY (April 30, 2006) http://www.ifc.org/ifcext/sustain ability.nsf/AttachmentsByTitle/pol_SocEnvSustainability2006/$FILE/SustainabilityPolicy.pdf. 92. See Gonzalez, supra note 73, at 10608.
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Ventosa-La Mata project include providing a steady stream of income to landowners on whose land the projects will be located; creating approximately 150 local jobs during the construction phase, and ten permanent full-time jobs during the operational phase of the project; and increasing economic activity for the local Port of Salina Cruz. 93 The Mexican government also boasts that the new wind projects in Mexico shall generate approximately 10,000 jobs directly and indirectly during the construction phase of the projects, and that around 374 permanent operation and maintenance jobs shall be created as a result of the developments. 94 The promise of jobs, however, appears as yet unfulfilled by the developers. For example, La Venta II, a Mexican-led development, apparently only employs eight people from the local community, 95 as many of the skilled workers used for the projects have been brought in from other parts of Mexico or, in many cases, the United States or Europe. 96 Further, as previously noted, even the La Mata-La Ventosa project, with a subsidiary of the largest American retailer as offtaker (or energy buyer), projected the creation of a mere 150 local jobs during construction and ten permanent full-time employees thereafter. 97 While the exact circumstances of the land leases and social and environmental impacts of the project may never be fully known except through extensive interviews with local indigenous communities and indepth empirical studies, 98 it is clear that the residents in the region see this round of development as beneficial to large, private interests, not their own, 99 and a continuation of the dispossession of communal lands. 100 It is uncertain whether the promises foretold by the developers shall ever bear fruit in La Ventosa; the only that thing that is known with some
93. For a full discussion of the numerous benefits claimed to accompany the La Ventosa-La Mata project, see International Finance Corporation, supra note 37, at para. 13. 94. INTER-AMERICAN DEVELOPMENT BANK, supra note 34. 95. NORTH AMERICAN CONGRESS ON LATIN AMERICA, supra note 25. 96. See INTER-AMERICAN DEVELOPMENT BANK, supra note 70 (stating that, with respect to the Eurus wind project, [t]here are currently about 400 to 500 workers on site, including approximately 200 workers from the La Venta Ejido (emphasis in original)). 97. See INTERNATIONAL FINANCE CORPORATION, supra note 37, at 48(iii). 98. Some limited research corroborates much of the anecdotal information provided in the popular press, although extensive mainstream media coverage of the indigenous resistance to the wind development is generally laudatory of the development. Cf. Mark Becker, Isthmus of Tehuantepec (July 17, 2007, 9:13 AM), http://www.yachana.org/reports/mex07/2007/07/isthmusof-tehuantepec.html; Trejo, supra note 71. 99. See Center for Strategic and International Studies, supra note 31; Hawley, supra note 58; In Mexico, Local Protests Mount at Iberdrola Affiliate Wind Farm, RENEWABLE ENERGY REPORT, Sept. 7, 2009, 2009 WLNR 18585118. See also Laplante & Spears, supra note 83, at 10001 (noting that in Peru, communities resent extractive projects because they derive few of the benefits while bearing most of the costs). 100. See See Ricardo & Diana, When the Wind Blows, the Cradle Will Rock, COLECTIVOS DE APOYO, SOLIDARIDAD Y ACCIN, April 2007, available at http://www.casacollective.org/ story/analysis/when-wind-blows-cradle-will-rock.
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certainty is that these landmark developments provide a blueprint for private investors aiming to invest in the region. Given the damaging effects of the activities to date, this fact does not bode well for the local indigenous population. IV. UNDERSTANDING PROJECT FINANCE On learning of the situation in La Ventosa, I was immediately drawn into the story. It is compelling and complex. However, one of the most intriguing aspects of this story, so full of fascinating elements, is that the project sponsors relied on project financing for the transactions. We have seen this before. The situation playing out in La Ventosa replicates itself in all corners of the world and across development industries. Indeed, the people of Peru, 101 India, 102 Argentina, 103 Burma, 104 Azerbaijan, Turkey,
101. The Camisea natural gas project is a thirty-year project that is touted by the InterAmerican Development Bank as enabling Peru to become one of the few Latin American countries to meet its internal energy needs and eventually export natural gas outside of the country. It involves the exploration and processing of gas deposits in the Camisea field in Peru; the transportation of the processed natural gas through over 1200 kilometers of pipeline; and the distribution of the gas. See Inter-American Development Bank, Camisea Project: Fact Sheet (Feb. 5, 2007), http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=837877 (last visited May. 20, 2011). The project is the subject of intense scrutiny because it requires pipeline construction in sensitive areas of the Andes, development of the natural gas in areas inhabited by indigenous groups, and the construction of a processing facility in an environmentally sensitive marine national park. See id. The complex project received financing through a consortium of banks and sponsors using project finance. See Latin American Oil & Gas Deal of the Year 2004, EUROMONEY INSTITUTIONAL INVESTOR PLC, Mar. 1, 2005, 2005 WLNR 27364850. See also Chloe Hayward, Project Finance: Record Financing for Peruvian LNG Project, EUROMONEY, Aug. 5, 2008, 2008 WLNR 27704713 (discussing related liquid natural gas pipeline that will export gas from Camisea field). Despite much attention paid to promoting the sustainability of the project, it has been troubled since inception, experiencing a number of pipeline spills and damaging the ecosystem of the surrounding area. See Bowen, supra note 91, at 73738. The project also appears to be part of a larger effort on the part of the Peruvian government to open up large swaths of rain forest to private energy and agriculture investment, resulting in the large-scale displacement of indigenous people. See Kelly Hearn, Peru Indians Demands Seen as Stoked by Chavez U.S.-backed President Pressured by Protesters, THE WASHINGTON TIMES, July 6, 2009, at A1. 102. In 1992, the Dabhol Power Corporation (DPC), a joint venture of the Enron Corporation, General Electric, and the Bechtel Corporation, contracted with the government of Maharashtra state in India to build a $3 billion electricity generating plant, the largest in the world. HUMAN RIGHTS WATCH, THE ENRON CORPORATION CORPORATE COMPLICITY IN HUMAN RIGHTS VIOLATIONS (1999), available at http://www.hrw.org/legacy/reports/1999/ enron/index.htm/. The project was heavily opposed by environmental activists and communities affected by the development. Id. In 1999, Human Rights Watch issued an extensive report detailing DPCs alleged complicity in human rights abuses carried out by state police that were paid to provide security for the company. Id. The report also claims that contractors of DPC engaged in a pattern of harassment, intimidation, and attacks on individuals opposed to the project. Id. 103. An Argentine NGO has been engaged in a pitched battle against the developer of a paper mill on the Uruguay-Argentina border. The project is one of the largest capital investments in Uruguays history, and is financed by project finance. See Vivian Lee, Note & Comment, Enforcing the Equator Principles: An NGOs Principled Effort to Stop the Financing of a Paper Pulp Mill in Uruguay, 6 NW. U. J. INTL HUM. RTS. 354, 35960 (2008). The complaint alleged that the mill would cause damage to the local environment and fisheries relied on by local populations. See id. at 36061. 104. Unocal Corporation, a California oil company, acting with an international consortium,
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Georgia, 105 inter alia, have borne acute witness to the degradation of their environment, exploitation of their natural resources, wholesale disregard for traditional land rights, and other well-documented abuses. These harms were all facilitated by project finance-based development. Project finance transactions may assume many different configurations; however, the basic project finance form is well understood and generally consistent across industries. By definition, project finance effectively relies on an income-generating asset and is self-financing as to debt servicehence the name, project finance. High amounts of nonrecourse debt, low initial equity contributions, and the use of a special purpose vehicle to conduct the affairs of the project further characterize project finance. 106 The form has roots dating back to the medieval period, 107 and the simplicity of the name obfuscates a world of complexity. 108 Despite this complexity, there is an underlying form, which is the subject of this article. A. Theoretical Underpinnings Project finance locates itself in the larger law and development narrative constructed by legal and political science scholars in the Global
participated in the development of the Yadana oil field in the Andaman Sea off the southern coast of Burma. The consortium allegedly paid the Burma military to provide security for the project. Residents of Burma claimed that they were relocated against their will, subjected to forced labor, assault, rape, torture, and saw friends and family murdered by the Myanmar State. See Eric Marcks, Avoiding Liability for Human Rights Violations in Project Finance, 22 ENERGY L.J. 301, 30608 (2001). The pipeline, at $1.2 billion, was the largest cross-border transaction ever conducted by the Burmese government, which was constructed using project finance. Id. 105. The Baku-Tblisi-Ceyhan Pipeline, financed by the IFC, the European Bank for Reconstruction and Development, and a group of private lenders, cost over $3.6 billion and, according to IFC documents, traverses 17,700 individual land parcels with a total of 60,000 landowners and reaches from the Caspian Sea to the Mediterranean Sea. IFC, IFC SUSTAINABILITY REPORT 2004 33 (2004), available at http://www.ifc.org/ifcext/sustain ability.nsf/Content/Publications_Report_Sustainability2004. The bank indicates that no physical displacement resulted from the pipeline, but thirty-three complaints to the IFCs ombudsmen indicate a host of other grievances, including, inter alia, issues with compensation for land acquisition, proper assessment of the environment in an area prone to landslides, and losses to fishing stocks. Compliance Advisor Ombudsman, Georgia/BTC Pipeline-30/Vale, http://www.ca o-ombudsman.org/cases/case_detail.aspx?id=71. Non-governmental agencies also report serious concerns related to worker rights and the environment. Press Release, CEE Bankwatch Network, BTC Outraged By Oil Companys Violations. Promised Highest Standards Are Sorely Lacking in Georgia (Feb. 6, 2004) (claiming that pipeline workers are required to work twelve to fourteen hours per day, including weekends and holidays); BP Accused Of Cover-up In Pipeline Deal, THE SUNDAY TIMES, Feb. 15, 2004, http://www.bakuceyhan.org.uk/BP%20accused %20of%20cover-up%20over%20pipeline%20deal.htm (discussing a document leak which indicated that British Petroleum failed to disclose safety design faults that could lead to an environmentally catastrophic leak in the pipeline). 106. See generally, Estache & Strong, supra note 2, at 34. 107. Kojo Yelpaala, Rethinking the Foreign Direct Investment Process and Incentives in PostConflict Transition Countries, 30 NW. J. INTL L. & BUS. 23, 62 (2010). 108. For a lengthy discussion of project finance and its variations, see generally SCOTT L. HOFFMAN, THE LAW AND BUSINESS OF INTERNATIONAL PROJECT FINANCE (Cambridge Univ. Press 2008).
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North, 109 and advanced by the Bretton Woods agencies. In The New Law and Economic Development, 110 Professors David Trubek and Alvaro Santos describe the law and development movement in terms of moments, which provides a useful, if simplified, lens through which to view the discourse. The First Moment, initiated in the 1960s, assumed that import substitution in the internal markets of states would facilitate growth, and states must direct limited financial resources to specified investment targets. 111 This moment emphasized the importation of public and regulatory law from more advanced states to developmental states in order to manage an increasingly complex legal and economic environment and remove limitations to natural macroeconomic processes. The focus in this moment was on capacity building within public agencies and modernization of the legal profession in order to support the dynamics of the developmental state, with an inherent suspicion in the abilities of private markets and foreign capital to create sustainable growth. 112 In the so-called Second Moment, beginning in the late 1980s, post-Cold War period, 113 the tenor shifted away from a focus on capacity building in the public sector and toward neoliberalism. By some accounts, the move toward privatization began as early as the 1970s with Margaret Thatcher, and continued with President Ronald Reagan in the 1980s. 114 In this moment, state intervention was seen as limiting the natural progression of development, and foreign investment became the overriding goal. The development of the law of private property and contract regimes would foster these goals, coupled with an emphasis on the judiciary as a way to limit the role of the state and promote markets. 115 In this moment, as Professors Trubek and Santos note, there was a belief that markets were markets, and the same legal foundations would be needed and could operate anywhere. 116 The concept of project lending also gained prominence in development circles, for industry could not be developed without infrastructurea consistent supply of electricity and the roads to
109. DAVID M. TRUBEK & ALVARO SANTOS, THE RULE OF LAW IN DEVELOPMENT ASSISTANCE: PAST, PRESENT, AND FUTURE, IN THE NEW LAW AND ECONOMIC DEVELOPMENT A CRITICAL APPRAISAL 79 (2006). 110. Id. 111. Id. at 5. 112. Id. 113. Id. at 3. 114. MICHAEL B. LIKOSKY, LAW, INFRASTRUCTURE, AND HUMAN RIGHTS 36 (Cambridge Univ. Press 2006); HOSSEIN RAZAVI, FINANCING ENERGY PROJECTS IN DEVELOPING COUNTRIES 51 (1996). 115. Tamara Lothian & Katharina Pistor, Local Institutions, Foreign Investment and Alternative Strategies of Development: Some Views from Practice, 42 COLUM. J. TRANSNATL L. 101, 11314 (2003). 116. TRUBEK & SANTOS, supra note 109, at 6.
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allow for the transport of finished products. 117 According to Trubek and Santos, in the Third, and current moment, the neo-liberal development is critiqued and disrupted. In particular, critics point to the limitations of transplanting laws without fully understanding the local institutions in place or the particular cultural context in which such transplantation takes place. 118 Moreover, the overemphasis on economic development and poverty alleviation at the expense of other development goals, such as freedom, is seen as ignoring the human aspects of development. 119 The World Bank has weighed in to critique policies it has supported as well, noting that transplantation of a formalistic rule of law to developing and/or democratizing countries could actually be counterproductive for economic, institutional, and political development, especially when informal mechanisms would be more effective and efficient. 120 Other critics push the inquiry further, querying the notion of the linear arc of development as a viable or even desired outcome with respect to developing the Third World. 121 Still others take an even more critical view, questioning the very dialectic frame that produced the development discourse. 122 Scholars such as Ruth Gordon and Jon Sylvester argue that the discursive production of the development frame has obfuscated the reality that the rules relating to development were and have always been a Northern construct. 123 The exportation of legal models and privatization mechanisms from North to
117. See Ruth E. Gordon & Jon H. Sylvester, Deconstructing Development, 22 WIS. INTL L.J. 1, 31 n.126 (2004). 118. See TRUBEK & SANTOS, supra note 109, at 67; Lothian & Pistor, supra note 115, at 104. 119. See generally AMARTYA SEN, DEVELOPMENT AS FREEDOM (1999) (recharacterizing development in more human terms). 120. TRUBEK & SANTOS, supra note 109, at 90 (citing World Bank, Legal Institutions of a Global Economy Home Page, http://www1.worldbank.org/publicsector/legal/index.htm). 121. TRUBEK & SANTOS, supra note 109, at 80 (discussing linear development as the presupposition that all nations [go] through similar states to reach a common end, represented in this kind of thought by the legal, economic, and social structures of the United States and Western Europe). 122. Joel M. Ngugi, The World Bank and the Ideology of Reform and Development in International Economic Development Discourse, 14 CARDOZO J. INTL & COMP. L. 313, 320 (2006) (quoting Duncan Kennedy, the World Banks attitudes toward development seen as a whole are the product of the underlying structure of economic forces and relations, which it legitimizes. That underlying structure is the current system of international economic relations, including the international division of labor, extraction of natural resources, banking and trading systems and supposedly supported by a world of liberal democracies.). See also Gordon & Sylvester, supra note 117, at 82 (The post war development discourse established a discursive practice that in turn established the rules of the game. This discourse permits the systematic creation of object, concepts and strategies, as it determines who can speak, from what points of view, and with what authority. It establishes the criteria that define expertise and that expertise was deemed to reside in Western systems of thought, values and ways of life.). 123. See LIKOSKY, supra note 114 at 38; Ngugi, supra note 122, at 32829; Gordon & Sylvester, supra note 117, at 73. See also Tayyab Mahmud, Postcolonial Imaginaries: Alternative Development or Alternatives to Development?, 9 TRANSNATL. L. & CONTEMP. PROBS. 25, 26 (1999) (noting that critiques of development remain imprisoned within the imaginary of development and therefore radical critique must move beyond the discourse of alternative development and begin to imagine alternatives to development.).
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South takes for granted that those in the Global South actually accept the underlying methodologies and psychologies supporting such importation. 124 This, such scholars argue, is flawed reasoning, and the underlying rules that produced the linear development model should be exposed and evaluated. 125 Project finance locates itself near the nucleus of this rich discourse. The discursive production of the development framework that evolved through the three so-called moments produced the same flawed theoretical understandings of development finance, specifically project finance. Similar to the development discourse, the more pervasive the use of project finance, the less penetrable, as a form, it became. Outsiders assumed that the outcomes resulting from infrastructure development were attributable to other causesthe corruption of transition states in the Global South, market imperfections, and necessary evils in the messy business of creating infrastructure. I suggest that the answer is hidden in plain sight, in the form itself. B. Project Finance and DevelopmentThe Mexican Example The situation unfolding in Mexico illustrates the complex relationship between the development narrative and the project finance form. The legal and regulatory frameworks promoted by the World Bank and IDB in Mexico encourage privatization mechanisms such as project finance to situate themselves in a discourse that assumes neutrality of the private law. 126 These interventions promote a form of energy production that removes the indigenous voice from decisions related to ancestral land, and by pushing for increased private engagement in potentially disruptive development, avenues for recourse become exceedingly narrow. Against the backdrop of assumed neutrality of law, project finance serves as a mechanism to advance the subordinating effects of the development discourse, even if such subordination lacks the obvious badges of intent. 127 A brief analysis of the emergence of project finance and its
124. See, e.g., Gordon & Sylvester, supra note 117, at 74 (The widespread acceptance of development as instinctive or natural has much to do with the power of the West to construct the prism through which the world is perceived.). 125. See id. at 8185 (discussing and exposing the discursive production of development concepts). These recent critiques of development are positioned within the ongoing critique of development that existed at the outset of the law and development movement. Early scholars questioned the efficacy of the modernization track and the narrative framing of development and underdevelopment in the Global South. E.g., David M. Trubek & Marc Galanter, Scholars in Self-Estrangement: Some Reflections on the Crisis in Law and Development Studies in the United States, 1974 WISC. L. REV. 1062 (1974). 126. See TRUBEK & SANTOS, supra note 109, at 14 (contrasting the concept of a neutral private law regime with the sphere of public or regulatory law, which is presented [in development thought] as coercive, and an intervention in an otherwise level playing field). 127. The ejido land contracts illustrate this subordinating effect. The contracts themselves are neither fair nor open, but widespread to effectuate the massive acquisition of land for the
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relationship to the development discourse, followed by an overview of the specific interventions deployed in Mexico, illustrates how project finance works hand in hand with the subordinating elements of the development discourse. The roots of modern project finance date back to the 1930s, when early investors in Texas oil fields perfected the project finance form. 128 However, it was not until the 1970s and 1980s that the use of project finance gained popularity. 129 The needs articulated by the law and development movement (e.g., the call for more law and the opening of emerging economies) closely tracked the re-emergence of project finance in the late 1980s and 1990s, during which time project finance emerged as a way for private actors to engage in the risky business of development and realize a robust return on investment. 130 Early seminars relating to understanding project finance acknowledged this unique feature of project finance, and emphasized its utility as a risk mitigation mechanism, especially for project developers who relied on the off-balance sheet features of the form. 131 These early seminars engaged the international finance community squarely during the Second Moment. The laws created during the Second Moment therefore provided an avenue through which private actors could engage in the risky process of infrastructure development, while simultaneously mitigating risk. Project finance served as a useful template; it could be used in multiple development contexts, rarely changing its essential shape. Even now, the focus on market development and private investment still leads the development discourse. 132 Despite the emergent critique of neoliberalism and the Washington Consensus, 133 and the questionable ability of private actors to act for the public benefit, 134 the Bretton Woods
erecting of windmills that will produce energy for corporations. In the name of green development, this large-scale land acquisition fundamentally shifts the relationship between indigenous groups and their land and disrupts traditional lifeways. 128. E.R. YESCOMBE, PRINCIPLES OF PROJECT FINANCE 6 (2002). 129. Id. (noting use of project finance in North Sea oil fields in the 1970s). 130. See ESTY, supra note 3, at 29; HOFFMAN, supra note 108, at 8. 131. Roger D. Feldman & Scott L. Hoffman, Project Financing 1987: Power Generation, Waste Recovery, and Other Industrial Facilities, 297 PLI/REAL 399, 415 (1987). 132. See Yelpaala, supra note 107, at 26 (noting World Bank study that points to need for two types of complementary investments: public and private). 133. The term Washington Consensus refers to the policies of international financial institutions (such as the World Bank and International Monetary Fund), emanating from Washington, D.C., in the 1990s, which prescribed prudent macroeconomic policies, outward orientation, and free-market capitalism for countries identified as developing countries. SARAH BABB, BEHIND THE DEVELOPMENT BANKS ix (2009) (quoting JOHN WILLIAMSON, LATIN AMERICAN ADJUSTMENT: HOW MUCH HAS HAPPENED? (John Williamson, ed., Washington, DC: Institute for International Economics 1990)). 134. See Yelpaala, supra note 107, at 52 (stating, [t]he primary objective of [multinational enterprises] is not economic development. . . . For developing countries in general, the evidence so far seems to suggest that economic development cannot easily be achieved without some deliberate and active state intervention.).
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agencies continue to play a vital role in producing the knowledge essential to effectuate Northern-led development. In the case of the wind development currently underway in Mexico, the World Bank and IDB have worked closely with the Mexican government to establish an ample opening to encourage private development of wind resources, advancing the subordination of indigenous interests. For example, the World Bank, working through its Large Scale Renewable Energy Development Project, has provided technical assistance to the Mexican governmental agencies that are engaged in the wind development sector. 135 Such agencies include the Ministry of Energy (SENER); the Mexican energy sector regulator, Comisin Reguladora de Energa (CRE); the Ministry of Environment and Natural Resources; and CFE. 136 The World Bank also assisted the Mexican government in obtaining carbon financing and $25 million in a Global Environment Facility grant for the La Venta III project, 137 one of the early Mexican test projects for wind energy. Further, the bank developed a system to monitor the avian strike issues associated with the La Venta II project and is working with the Mexican government to support social and economic development policies to support the ejido landowners under Mexicos traditional system of land tenure. 138 The World Banks assistance is forward-looking, as the agency is working with the Mexican government to conduct a Strategic Environmental Assessment to facilitate and optimize the planning and siting of future wind farm developments. 139 The IDB, a key funder in each of the La Mata-La Ventosa and Eurus wind projects, also plays a role in easing the path for future wind development in Mexico. The agency is collaborating with the Mexican government to create a regulatory framework to the 2008 Renewable Energy Law, which grants the CRE and SENER powers to create the relevant regulatory framework required to implement the new law. 140 The IDB will also work with the Mexican government to remove barriers to expanding the development of non-traditional energy forms. 141 Their efforts will consist primarily of commissioning studies to evaluate the existing power generation, interconnection, and transmission mechanisms and the financial potential of renewable energy projects supported by
135. World Bank, Large-scale Renewable Energy Development Project (June 15, 2006), http://web.worldbank.org/external/projects/main?pagePK=64312881&piPK=64302848&theSiteP K=40941&Projectid=P077717. 136. See INTERNATIONAL FINANCE CORPORATION, supra note 37, at para. 13. 137. Id. 138. Id. 139. Id. 140. See id. at para. 22. 141. See id. at paras. 5, 22.
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public and private funds, 142 all of which means the inevitable proliferation of privately-led wind development in El Istmo. The stated goals of such efforts include reducing entry costs and risks for future developers, and creating an attractive market for such developers to engage in the wind development market. 143 Future projects are also expected to garner carbon credits through the United Nations CER credits framework, which will provide a significant investment incentive for developers. Such future developers may elect to supply energy to the CFE as independent power providers, but they will more than likely participate in the Mexican renewable energy revolution through the more profitable autogeneration framework. 144 Therefore, it is unlikely that local populations will fully reap the benefit of a resource that resides in abundance at their doorstep. In the name of sustainable development and profits, the North will serve as the beneficiary of a windfall, all facilitated by the technical assistance provided by a Bretton Woods agency and the IDB. Project finance is a critical component of this arrangement, as illustrated in the Oaxaca wind projects, where private land contracts dictate the terms of engagement between indigenous individuals and private entities. This framework, at the outset, ignores traditional decision-making mechanisms of the ejido, 145 and, if accounts from the region are accurate, creates an instant power differential in which the indigenous landholder immediately divests its rights to terminate leases that, at 25-year renewable increments, will affect generations. Although limited contractual remedies may be available, to what end? Once the windmills are in place, the spiritual, physical, and historical connection to the land is forever severed. This private contractual process not only operates to sever traditional indigenous connections to land, but it simultaneously attenuates the relationship between the state and the landholder. By forcing reliance on private land agreements, the developer affectively undermines
142. See id. at para. 22. 143. See id. at paras. 5354. 144. As noted by the IFC in materials describing the attractiveness of the Mexican private wind development sector, [t]he autogeneration framework for private wind power developers is effective because it allows private developers to earn tariffs which are higher than those paid to private wind power developers by CFE through the [independent power provider] process, but which are lower than what CFE would charge the industrial consumer directly. Id. at para. 11. In an independent power provider (IPP) scenario, a private developer produces its own energy for sale to a public utility. Erik J. Woodhouse, The Obsolescing Bargain Redux? Foreign Investment in the Electric Power Sector in Developing Countries, 38 N.Y.U. J. INTL L. & POL. 121, 122 (2006). 145. Usos y costumbres is a term that encompasses a wide range of local tradition, customs, and decision-making in indigenous communities in Oaxaca, including the use of an assembly to conduct the major affairs of the community. See Stephen, supra note 27. Any large-scale transfer of ejido land would likely be handled through the assembly process. See BROWN, supra note 73, at 12, 20.
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international legal instruments that require the state to respect indigenous lifeways. 146 These instruments are of little force against private actors, but states, even in the most basic political sense, face more scrutiny in navigating issues affecting indigenous rights. 147 In these ways the development discourse, as discursively produced by the Mexican legal instruments promoted by the World Bank and IDB, and contractually enforced by project finance participants, subordinates traditional indigenous rights. What becomes evident in the foregoing illustration is that the fallacy of the development discourse is so tightly woven within the fabric of infrastructure finance that it logically follows that such financing mechanism would also be infected. 148 Locating such flaws, however, is a crucial first step to subverting what has become a common financing mechanism for infrastructure development. The non-neutrality of corporate legal frameworks as imported to the Global South has been examined by others, 149 but even if we assume neutrality with respect to the legal framework that encourages private development, a closer examination of the transaction forms encouraged by these legal frameworks reveals that the assumptions of neutrality embedded in these forms must also be disrupted. 150
146. In 1990 Mexico was the first state to ratify International Labor Organization Indigenous and Tribal Peoples Convention, 1989, which recognizes the aspirations of [indigenous] peoples to exercise control over their own institutions, ways of life and economic development and to maintain and develop their identities, languages and religions, within the framework of the States in which they live. . . . International Labor Organization (No. 169) Concerning Indigenous and Tribal Peoples Convention, adopted June 27, 1989, available at http://www.ilo.org/ilolex/cgi-lex/convde.pl?C169 (last visited Feb. 21, 2011). Moreover, the international community has moved toward recognition of indigenous rights. See S. James Anaya & Robert A. Williams, Jr., The Protection of Indigenous Peoples Rights Over Lands and Natural Resources Under the Inter-American Human Rights System, 14 HARV. HUM. RTS. J. 33, 36 (2001) (discussing Inter-American human rights systems recognition of indigenous peoples rights over their traditional lands and resources). 147. See Stephen, supra note 27 (discussing Article 4 of the Mexican Constitution, which protects and promotes the development of [indigenous] languages, uses, customs, resources, and specific forms of social organization). 148. This might be argued of foreign direct investment in general. As Professor Kojo Yelpaala notes, left to its own devices, [foreign direct investment] is unlikely to generate growth, lead to meaningful technology transfer, or create the internal links necessary for the development of certain regions of the world. Yelpaala, supra note 107, at 29. 149. Professor David Trubek notes that law is used to intervene in markets to correct market failures and allocate risk, so the assumption of importation of a neutral legal framework to promote private market development is flawed. TRUBEK & SANTOS, supra note 109, at 87. Professor Yelpaala discusses the inefficacy of foreign direct investment in the mining context of Sub-Saharan Africa, noting specifically the scoop and ship operations that mine natural resources without refining or developing the resources. Such operations, Professor Yelpaala notes, yield little positive impact on the host country in the form of technical spill-over effects or employment opportunities, but do provide a high return to the investor. This form of foreign direct investment, he argues, creates a low-level development trap. Yelpaala, supra note 107, at 29. 150. See, e.g., Mahmud, supra note 123, at 26 (noting that [p]ost-coloniality, then, may be conceptualized as an effect of, and a condition of subjection to, the development project, with the latter seen as a discursive structure, a disciplinary apparatus, an institutional modality, and a
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The key features of a project finance transaction include: (1) an equity investment by project sponsors into a special purpose legal entity formed to build the project; (2) a high debt-to-equity ratio, where debt of the project ranges from seventy to ninety percent of the total project cost; (3) no recourse or limited recourse to the project sponsors for defaults related to the project debt; (4) lender reliance on cash flows from the project to service the project debt; and (5) lender reliance on project contracts and assets, rather than the sponsors assets, as security for the project debt. 151 Each feature is described in more detail below, along with a brief description of the principal project contracts. The typical project finance transaction begins with an equity investment by a project sponsor or sponsors into a project company. The sponsors serve as the project promoters and principal developers for the project. 152 In modern project finance transactions, the number of equity investors ranges from one to three. 153 These investors are corporations with recognizable names, such as Texaco, Pemex, Shell, and BP. Project finance may also involve a co-investment by a sovereign (e.g., a publicprivate partnership); however, the analysis herein is limited to private investments that involve agreements with the sovereign for the provision of services, but in which the sovereign is not an initial co-investor. Sovereign involvement would significantly alter the analysis. A sovereign possesses obligations to its polity, and even dictatorial regimes are subjected to a level of scrutiny not yet faced by transnational actors in the international community. The principal agreement to which the project sponsors are party is the shareholder agreement. The shareholder agreement governs the relationship between the joint venture (e.g., the sponsors, as equity) in the creation of a special-purpose entity (SPE) project company whose sole purpose (in the corporate sense) is to develop the project. The project company therefore serves as the borrower and contracting party for all transactions related to the project. The project company also engages a political risk insurer to insure against political and other hostcountry risks that may arise throughout the course of the project. 154 In addition, the debt of the project company does not appear on the balance
meta-theory of history whose genealogy is firmly rooted in the colonial encounter.). 151. YESCOMBE, supra note 128, at 78. When questioned about the structural components of each of the La Mata-La Ventosa and Eurus wind projects, IDB officials simply responded that the projects contained standard project finance features. See E-mail from Rachel Robboy, supra note 47. 152. YESCOMBE, supra note 128, at 34. 153. ESTY, supra note 3, at 2. 154. See Marcks, supra note 104, at 31819.
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sheet of sponsors with less than a majority stake in the company. 155 At the outset, the project company enters into a government support agreement 156 or concession agreement concerning the goods the project will provide. The government support agreement essentially provides that in exchange for the building of the project, the sovereign shall provide to the project company certain compensation. Such compensation may involve beneficial tax treatment, guaranteed payment rates for project output, performance guarantees, permits, 157 and other favorable treatment. 158 In countries where the private investment in an industry is novel, the government services agreement will provide the legal framework for the transaction, including debt-to-equity ratio requirements, share retention requirements for equity investors, provision of work permits, a waiver of sovereign immunity, and consent to arbitration. 159 The concession agreement is a major project document that allows the project company to construct and earn revenues from the project in exchange for providing a public service. It is similar to, but distinct from, the government services agreement, which governs the relationship between the project company and the government. 160 The project company also engages a contractor to design and construct the project. This is usually a private entity, called the engineering, procurement, and construction contractor (the EPC Contractor, the underlying contract, the EPC Contract). The EPC Contractor agrees to design, engineer, and construct the project at a fixed-price, on a fixed dated, and on a turn-key, basis, meaning that the EPC Contractor shall deliver the keys to the fully-constructed, fully-operable project by a date certain to the project company. 161 EPC Contracts are preferred by lenders to most infrastructure and energy transactions because of their ability to shift the risk of construction delay to the EPC Contractor. 162 They are inapplicable in extraction projects (e.g., oil and mining) or projects that rely on the creation of a network (such as
155. From the perspective of the project sponsor, accounting rules in the United States generally require the consolidation of financial statements of a company and certain of its subsidiaries and other entities over which it can exercise control. A subsidiary controlled more than 50 percent by the parent company is consolidated on a line by line basis with the parent. Otherwise, the equity method of accounting is used whereby the investment in the subsidiary is shown as a one line entry. Debt in such circumstances is not reported on the parent companys financial statements. HOFFMAN, supra note 108, at 9. Changes in United States accounting rules that went into effect in 2010 could limit the availability of off-balance sheet financing going forward. See BASEL COMMITTEE ON BANKING SUPERVISION, REPORT ON SPECIAL PURPOSE ENTITIES 2 (2009), http://www.bis.org/publ/joint23.pdf. 156. YESCOMBE, supra note 128, at 12. 157. Id. at 122, 126. 158. Id. at 9. 159. Id. at 12526. 160. Id. at 10. 161. Id. 162. Id.
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telecommunications). 163 Most large projects also involve an operation and maintenance contract (the O&M Contract), wherein a contractor agrees to provide general operations and maintenance services to the project to ensure that the projects operations and management-related fees stay within budget. 164 The operations and maintenance contractor (O&M Contractor) provides key personnel, such as the project manager, and sometimes other human resources to train project employees regarding the start up of the facility. 165 The O&M Contractor receives incentive payments for efficient operation of a project that exceeds projected operation targets. 166 If the project requires a fuel input, the project company must enter into a fuel supply contract (the Supply Contract) in order to supply the project with the fuel (e.g., oil, gas, or coal) required to run the facility. The process of negotiating the Supply Contract requires an understanding of prevailing fuel rates and projected supply; securing price guarantees for the fuel input becomes a critical aspect of the overall financial picture of the project. 167 The input requirements of the project are closely linked to the output requirements and the negotiated rates set forth in the output contract; the timeline of the Supply Contract should match the term of the output contract. 168 The output contract is arguably the most important document among the project contracts, and may take the form of a power purchase agreement, which is sometimes also confusingly called a concession agreement (the Offtake Agreement). 169 This principal project document dictates the revenue stream that will be generated by the output of the project. 170 The parties to this agreement are usually the project company and a utility, which may be a government entity (the Offtaker). The Offtake Agreement contains several features related to pricing. A common feature is the take or pay arrangement, where the utility agrees to purchase the projects capacity, or pay the project company in lieu of purchasing the projects output. 171 Other payment methods include the long-term sales contract, 172 the hedging contract, 173
163. Id. 164. Id. at 115. 165. Id. 166. Id. at 116. 167. Id. at 117, 180. 168. Id. at 117. 169. Id. at 70. 170. Id. 171. Id. at 72. 172. Under a long-term sales contract the Offtaker agrees to purchase a fixed amount of output at the market price or agreed market index. Id. at 71. 173. In a hedging payment arrangement the project company hedges the price of its commodity by entering into an agreement with an entity to whom it may sell the output if the
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the contract for differences, 174 and the throughput contract. 175 The Offtake Agreement, and the pricing mechanisms therein, provide the critical justification for the projects financing. In the case of the Mexico wind developments, Wal-Mart, Cemex, and CFE are the offtakers of the electricity generated by the wind farms. The stability of these entities provides significant security to the project sponsors, and comfort to the lenders regarding the future income stream of the projects. With respect to financing, project finance transactions are typically non-recourse, which means that in the event of a default, the lenders recourse is only as to the project assets, and not the assets of the sponsor. 176 During the initial, riskier phases of the project development, lenders may also request a sponsor guarantee of the project company debt or allow some recourse to the sponsors assets (limited recourse). 177 As in the La Mata-La Ventosa wind project, these limited recourse features often dissolve after completion of the initial phase of the project, after which time the project reverts back to a non-recourse project. 178 When the parent does not own more than fifty percent of the project company, the project debt does not appear on the balance sheet of the project sponsor. 179 This arrangement frees up the sponsor to invest in multiple projects without carrying their respective liabilities. 180 There is some indication that reliance on this benefit of project finance transaction is declining in the U.S. and the United Kingdom; 181 however, scholars still point to the availability of off-balance sheet financing as a critical incentive to electing the project finance form over standard corporate finance, where debt appears on the project sponsors balance sheet. 182 Because of the capital requirements of infrastructure projects, the debt-to-equity ratio of project finance transactions is high, meaning there is typically a low initial equity investment and substantial debt required to finance the cost of the project. The debt-to-equity ratio varies, but could
price of the commodity dips below a certain price, but who has the right to purchase the output from the project if the price exceeds a certain price. Id. at 71. 174. A contract for differences permits a project company to sell output on the market and not to an Offtaker. If the market price falls below a certain level, the Offtaker will pay the project company the difference. If the price exceeds a certain level, the project company will pay the Offtaker the difference. Id. 175. The throughput contract, or transportation contract, charges a user for use of a pipeline if such user agrees to use it to transport no less than a certain amount of product, such as oil, and pay a minimum price for use of the pipeline. Id. at 72. 176. HOFFMAN, supra note 108, at 8. 177. Id. at 89. 178. Id. at 9. 179. Id. 180. Conversely, if the sponsor owns more than fifty percent of the project company, U.S. accounting rules require the consolidation of the parents and SPEs financial statements. See id. 181. Id. at 10. 182. Duong, supra note 17, at 78.
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be as low as 75% in some cases, or as high as 100% in others. 183 Ratios between 80-90% are common, with lenders, and sometimes host governments, requiring more of an equity commitment in the Global South. 184 In general, the lenders set forth the equity requirements, understanding that the more a project sponsor has at stake in a particular project, the more likely it is that such sponsor will be committed to see the project through. 185 Because wind had never been privately developed in Oaxaca, the debt-to-equity ratios of the Oaxaca projects were lower than anticipated in future projects, which are expected to be financed almost entirely by private debt. 186 Given that the players in Oaxaca wind development are consistent, such investors were presumably willing to advance more of an initial cash outlay in early projectsLa Venta, Eurus, and La Mata-La Ventosain anticipation of higher debt-to-equity ratios in future projects. Project lenders also obtain collateral security in the form of contract assignments and project revenue in order to step into the shoes of the project company in the event of default and to support the underlying debt obligations of the project. 187 This is standard and largely seen as an advantage to sponsors, whose assets are not placed in jeopardy as a result of the financing. Notably absent from the transaction are members of the community that hosts the project. Although the World Bank Inspection Panel aims to integrate the voices of individuals affected by large-scale development into discussions regarding a project, such engagement is limited to stateled projects involving the World Bank. 188 In the private development context, such community involvement is at the discretion of the developers. 189 For highly controversial projects, engaging the community is critical to prevent construction delay or disruption to plant operations, but for outsiders to a region, determining whose voice should be added to the negotiations can be daunting. Moreover, as illustrated by the difficulties faced by wind developers in El Istmo, such engagement is typically limited in its ability to affect, on any meaningful level, the trajectory of a well-financed project. 190
183. HOFFMAN, supra note 108, at 10. 184. Id. 185. Id. at 10. 186. Project Finance and Infrastructure Finance, supra note 59. 187. HOFFMAN, supra note 108, at 8, 11. 188. See The Inspection Panel, About Us, http://web.worldbank.org/WBSITE/EXTERNAL/ EXTINSPECTIONPANEL/0,,menuPK:64129249~pagePK:64132081~piPK:64132052~theSiteP K:380794,00.html (last visited May 20, 2011). 189. Laplante & Spears, supra note 83, at 7883 (discussing the ways in which community stakeholders are brought into the development process, which is largely at the discretion of developers). 190. See id. at 8788 (noting that consent of affected communities would be preferable to mere consultation, where the developers simply hear community concerns).
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This highly complex transactional structure brings with it substantial transaction costs; however, developers, lenders, and host governments rely on several rationales to support its continued popularity. Such rationales can be viewed from both outside and within the transaction form. I begin by examining the external rationales. D. External Rationales for Project Finance The rationale underlying the discursive shift from public to private financing of infrastructure consists of two main points, one practical, and the other a bit more nuanced. Practically speaking, post-conflict and transition states following the linear modernization track emerged from the 1960s and 1970s saddled with debt and unable to finance large, expensive infrastructure projects, seen as risky investments by private enterprises. 191 This created quite a conundrum, but to no surprise, the same parties involved in the lending and structural adjustment programs that led to many of the sovereign debt problems emerged with solutions to the liquidity crisis facing states in the Global South. 192 The proposed solution? Private financing of public infrastructure projects. The more nuanced argument proffered by the development community, including the World Bank and other multilateral lenders, in support of private infrastructure development, is that the market is better positioned to bear the costs of development and, in the case of infrastructure, the professional expertise provided by international developers allows for more efficient project development. 193 Evaluating the efficiency argument provides a useful starting point. Project finance, development proponents argue, is a relatively efficient way to bring public works projects to fruition. As illustrated by Mexicos efforts to provide a legal framework that is attractive to wind development, host countries buy into this rationale by providing incentives for various types of development and making investment more attractive. Project developers benefit from this arrangement, which is sometimes critiqued as providing a reverse subsidy that flows from a developing country to a corporation that resides in a developed economy, 194 because the host government is unlikely to resist the
191. See LIKOSKY, supra note 114, at 38. 192. LIKOSKY, supra note 114, at 39 (noting that the shift to privatization was strategic and involved substantial participation by international institutions); Gordon & Sylvester, supra note 117, at 42 (noting that structural adjustment programs often created investment climates in the Global South favorable for private interests). 193. David Kennedy, The Rule of Law, Political Choices, and Development Common Sense, in TRUBEK & SANTOS, supra note 109, at 130. See also HOFFMAN, supra note 108, at 17. 194. See Yelpaala, supra note 107, at 27, noting that several studies have questioned the efficacy of tax and other fiscal incentives for attracting [foreign direct investment (FDI)] and that one such study questioned the theoretical foundations of tax incentive policies and concluded that not only were tax and other fiscal incentives ineffective instruments for attracting
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activities of the project developers. 195 In theory, host governments also benefit by importing capital that would otherwise be unavailable to furnish public goods. 196 In the end, the theory provides, the country as a whole is benefited by the efficiency of development experts. This efficiency argument does not fully account for all of the harm that accompanies project development. Moreover, the argument purports to distribute comprehensively the costs and benefits of the project. Once again, Oaxaca provides a useful illustration. On its face, the development in Oaxaca appears to be a win-win situation, and perhaps a net gain. The energy produced is clean; the wind is virtually free, save land rental fees; and the corporations purchasing the energy are no longer relying on carbon-dioxide-producing elements to power certain portions of their operations. Looking deeper, however, the social and environmental externalities emerge. Although our Northern lens prevents full understanding and quantification of the true social costs of the project, 197 they are probative of a less-definite balance of costs and benefits. Also included in the efficiency rationale is the suggestion that project finance allows the economic integration of developed and developing economies because a number of the projects involve the exploration of commodities that are exported to developed countries. 198 This is certainly the argument promoted in Oaxaca; however, as seen in certain Amazonian regions, such integration could result in the widespread devastation of previously pristine environments and the traumatic disruption of the community in which such projects are located. 199 In this context, project finance, as a tool to aid the shift from public to privatelyled development, provides the path of least resistance. The private development of infrastructure allows host governments to move away from the prominent role of project developer and bridge capital shortfalls. In doing so, host governments are also able to shift development risks away from public entities and toward private actors and thus avoid many of the negative reputational and political outcomes associated with state-led development. If project finance is the chosen
FDI, but they also provided a form of perverse reverse subsidies from impoverished and weak recipient states to affluent capital exporting countries. 195. See, e.g., HOFFMAN, supra note 108, at 17 (discussing emergence of private sector and general acceptance by host governments that the private sector is often better able to develop, construct, and operate large-scale infrastructure projects.). 196. See id. (discussing limitations on host governments ability to obtain financing for infrastructure projects). 197. See, e.g., Gonzalez, supra note 73 at 13637 (noting that the theory of comparative advantage does not take into account the powerful spiritual and cultural connection indigenous peoples have to their land). 198. Dinesh D. Banan, International Arbitration and Project Finance in Developing Countries: Blurring the Public/Private Distinction, 26 B.C. INTL & COMP. L. REV. 355, 35960 (2003). 199. See supra note 101 (discussing the Camisea development).
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method of delivering infrastructure, these shifted risks are further shifted by private developers onto third parties through the contractual mechanisms discussed in Part V. In many cases, the sovereign is among the group bearing the risk of development, but in the end, the sovereign still avoids holding the bag; any risk it bears is ultimately borne by the people, 200 and private actors may be blamed for any resulting negative externalities. The end result is a circular game of finger pointing, where adversely affected persons are left without a clear avenue for redress. 201 Underlying the cost and efficiency rationales is a subtle, but related, rationale. Project finance is unique in its ability to allow corporate actors to engage in the foregoing risky and profit-maximizing public-goods producing behavior under the full protective guise of private activity. Currently a growing body of scholarship attempts to create a human rights framework around such transnational corporate behavior, but for now, the elusive quality of private behavior in the public context continues to evade meaningful review. 202 Human rights advocates have also identified the private nature of project contracts as significantly limiting with respect to achieving accountability for various atrocities that occur in the development context. 203 Michael B. Likosky alludes to this difficulty in his work, Law, Infrastructure and Human Rights, 204 noting that the penumbra of project finance creates a gray area of activity wherein actors are difficult to identify. This is evident in Oaxaca, where farmers allege that access to their own land leases, in which they serve as landlords, were not provided. Moreover, the Inter-American Development bank and IFC each declined to provide this author with detailed information regarding the Eurus wind project, the largest wind
200. See HOFFMAN, supra note 108, at 75 (noting that, host government guarantees can undermine the benefits of private sector involvement . . . . impose significant costs on the host countrys taxpayers, and further erode the countrys financial health.). In addition, Hoffman notes, the risk structure of a project can allocate too much risk to the host country, leaving the project company with insufficient financial responsibility for taking excessive risks. Id. 201. See, e.g., supra note 102 (discussing Dabhol case). 202. See, e.g., Jena Martin Amerson, Whats in a Name? Transnational Corporations As Bystanders Under International Law, 85 ST. JOHNS L. REV. (forthcoming 2011) (using bystander framework to discuss transnational actors assumed role under international law); Rachel J. Anderson, Reimagining Human Rights Law: Toward Global Regulation of Transnational Corporations, 88 DENV. U.L. REV. (forthcoming 2011) (Failure to regulate the power, wealth, and influence of transnational corporations is a weakness in human rights law that should be remedied.); David Kinley & Rachel Chambers, The UN Human Rights Norms for Corporations: The Private Implications of Public International Law, 6 HUM. RTS. L. REV. 447, 450 (2006) (discussing the need for uniform and enforceable international standards for transnational corporations). 203. In addition, the lack of transparency with respect to such contracts prevents sovereigns from negotiating market terms with respect to their individual extractive projects. See generally, PETER ROSENBLUM & SUSAN MAPLES, CONTRACTS CONFIDENTIAL: ENDING SECRET DEALS IN THE EXTRACTIVE INDUSTRIES (2009) (including a comprehensive review of host country contracts with corporations in the extractive industries and arguing for greater transparency). 204. LIKOSKY, supra note 114, at 4445.
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project ever developed in the Americas. 205 In this development context, accountability is a significant challenge. 206 E. Internal Rationale for Project Finance Full consideration of the efficiency rationales espoused by project finance proponents suggests that external rationales provide the most support for deploying project finance; however, the internal rationales provide more compelling evidence for the proliferation of the form. Project finance can be viewed as a revenue-generating mechanism. The name suggests as much. The project finances itself. Investors continue to see this as a viable option because if the project fails, the banks typically only seek recourse through the projects assets, not the assets of the sponsors. 207 If the project succeeds, the project will generate proceeds to pay down the underlying project debt and eventually provide sponsors with an attractive return. Thus, the prevailing literature states, project finance, as a form, provides an avenue for developers to engage in infrastructure transactions that, from a risk-management perspective, would otherwise be cost prohibitive. 208 This provides useful cover for parties conducting project finance transactions because it allows such actors to justify their risk-mitigating activities, which comprise the core of the project finance form and which may have harmful effects on third parties. Inside the transaction form, project finance fundamentally serves as a risk-allocation structure. 209 In addition, its perceived profitability and
205. E-mail from Fuphan Chou, International Finance Corporation, to author (Jan. 13, 2011, 16:37 CST) (on file with author); E-mail from Rachel Robboy, supra note 47. 206. LIKOSKY supra note 114, at 24 (quoting CLAIRE CUTLER, PRIVATE POWER AND GLOBAL AUTHORITY: TRANSNATIONAL MERCHANT LAW IN THE GLOBAL POLITICAL ECONOMY 5 (2003): As a complex mix of public and private authority, the mercatocracy [transnational merchants, private international lawyers and other professionals and their associations, government officials, and representatives of international organizations] blurs the distinction between public and private commercial actors, activities, and law.). Likosky notes, moreover, that so much of the activity of the political economy now occurs in a zone which is truly intermediate between its public and private sectors; accordingly, privatization occurs between the realms of public and private law. (quoting M Freedland in Law, Public Services, and Citizenship New Domains, New Regimes?, in PUBLIC SERVICES AND CITIZENSHIP IN EUROPEAN UNION LAW: PUBLIC AND LABOUR LAW PERSPECTIVES 1, 6 (1998)). See also id. at 42 (noting that [t]he particular mixes of state and non-state actors involved in transnational [public private partnerships] are diverse. Thus, when it comes to human rights, nongovernmental organizations and community groups find themselves targeting varied public-private actor configurations.). This underlying incentive for employing the project finance mechanism is no less worthy of discussion and exploration, and shall be the subject of a future project. 207. See RAZAVI, supra note 114, at 251 (noting that project finance-based finance does not depend on the credit support of project sponsors; in project finance, the lender looks primarily to the revenue stream created by a stand-alone project for repayment and to the assets of that project as collateral). 208. See Duong, supra note 17, at 80 (Without the type of financing structure that helps buffer the corporate sponsor against investment risks, the corporate sponsor may not invest in a foreign country unless the profit margin is extremely high . . . .). 209. Professor Benjamin Esty notes that [o]ne of the primary reasons why managers say they use project finance is to achieve better risk mitigation and improved risk allocation. Yet,
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self-governing features all provide attractive incentives to rely on this method of finance. Each rationale is addressed in turn. Infrastructure and energy projects carry certain risks, and project finance is designed to mitigate the risks to project sponsors without affecting their creditworthiness. 210 The long-term debt received by the project affects neither the balance sheet nor assets of the project sponsors. These benefits are well known, and as Scott Hoffman, author of a comprehensive treatise on project finance, states, [p]roject financing is used by companies that desire any or all of several objectives. Established, well-capitalized corporations often select a project finance structure to assist in undertaking large debt commitments with a minimum of risk. 211 This creates an interesting paradox. The risks inherent in infrastructure development do not go away on initiation of a development project. Rather, in project finance, such risk is distributed throughout the structure through various contractual mechanisms, described more fully in Part III. 212 These mechanisms diffuse risk as to the sponsors and developers, making it difficult, if not impossible, to correlate negative outcomes to their original source and thus lead to an externalization of these inherent risks. 213 With respect to internal economics, project finance is profitable when compared with low leverage transactions. 214 The finance structure of a project finance deal rewards equity investors for taking on more project debt (at the special purpose entity level), given that lenders generally accept lower returns than equity investors. 215 Interest is also tax deductible, which further cheapens the value of debt as compared to equity. 216 Finally, project finance is a self-contained, self-regulated, mechanism that relies on its own highly negotiated terms to deliver the goods. Project financiers are famously creative, and while the basic components of a project finance transaction are fairly standardized, no two deals are alike. 217 The advantage of this framework is that developers may push the
most of the same techniques used to mitigate project risk (e.g., offtake agreements, fixed-price construction contracts, etc.) and to allocate project risk could be replicated in a corporate financed transaction. The intriguing question is which aspects of risk management cannot be replicated in a corporate setting. (Emphasis added.). ESTY, supra note 3, at 9 n.9. 210. Banan, supra note 198, at 356. 211. See HOFFMAN, supra note 108, at 8. 212. See Marcks, supra note 104, at 320. 213. See discussion infra at Part VI. 214. See HOFFMAN, supra note 108, at 15 (illustrating that in low leverage scenarios, profits are divided by a greater amount of equity, whereas in a high leverage situation profits are divided against a lower equity number, increasing the overall return). 215. See id. 216. Id. at 15. 217. See YESCOMBE, supra note 128, at 7 (each deal has its own unique characteristics); HOFFMAN, supra note 108, at 78 (noting that project finance transactional structures are virtually unlimited by the creativity and flexibility of bankers and lawyers.).
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transactional boundaries to maximize revenue. In emerging markets, creativity is critical to managing unknown risks. 218 Also, given that the transactions involve mostly private parties, the legal framework of the host state is less outcome determinative; more important is a partys leverage. 219 This can create tension between the host government and the project developers, especially with respect to waiving sovereign immunity and submitting to an arbitration tribunal. 220 More troubling, however, is the inability of parties likely to be affected by the transaction to penetrate the form in any meaningful way to affect its terms. 221 This disenfranchisement is not the subject of this article, but is closely connected to the most well-understood aspect of project financeits ability to diffuse risk. V. PROJECT FINANCE AS A RISK DIFFUSION MECHANISM Early proponents of project finance as a mechanism for foreign direct investment believed that no single external legal framework was outcome determinative with respect to the decision to invest. 222 Instead, access to raw materials, receptiveness of the foreign market to the product to be exported, and geographical location of the host country with respect to other markets were believed more important to investors. 223 The instability of the legal regimes in the Global South was also viewed as a liability to early investors, but through project finance, investors could control the terms of their investment through reliance on private contract. Risks inherent in the development project were therefore handled within the project structure, rather than vis--vis a corporate legal schema that distributes risks. As such, the parties imported a form with the ability to create a quasi-governmental, but private, legal framework, replete with the requisite checks and balances. The foregoing reflects a fundamental shift from reliance on a public forum to manage and distribute risks to a private, contractual mechanism
218. See id. 219. See Estache & Strong, supra note 2, at 6 (noting that it is the best and most experienced negotiator that ends up bearing the least amount of risk.). 220. See Banan, supra note 198, at 368. 221. Laplante & Spears, supra note 83, at 83, noting that the primary critiques emerging out of second generation corporate social responsibility initiatives acknowledge that [c]onsultation as a model of engagement with affected communities cannot address the underlying root causes of community opposition because it do[es] not involve sharing or transferring decision-making authority to those who will be directly affected . . . requires only an exchange of information . . . and is rarely an empowering form of public engagement. (quoting World Resources Inst., Development Without Conflict: The Business Case for Community Consent 7 (2007), http://www.wri.org/publication/development-without-conflict). 222. See Lothian & Pistor, supra note 115, at 109 (noting that in a discussion with a project finance attorney, such attorney stated that [n]o fixed set of legal entitlements could guarantee the economic conditions for the projects success or the goodwill or the social acceptance required for both the project and the country to move forward.). 223. Id.
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for such tasks. While the private management of risks has yielded substantial rewards for developers, it has effectively excluded the public from meaningful, consensual, participation in large-scale projects. 224 The features highlighted below indicate the specific ways in which project finance provides a unique shield to distribute risk within the form and, subsequently, away from investors. A. High Debt-to-equity Ratio As discussed, in contrast to corporate financing, project finance provides sponsors with the unique benefit of limiting risk exposure to the initial equity investment in the project, while offering such equity investors the opportunity to enjoy the benefits of a successful project. Sponsors may spread the financial risk by sharing the initial equity contribution with other parties. 225 As previously stated, the lenders or the host government may dictate the amount of equity contribution. A project identified as having strong potential cash flows might be structured with a debt-to-equity ratio of 90% to 100%, while a higher risk project might involve upwards of 40% initial equity investment. 226 Although a failure to develop the project would mean a loss of the equity investment, such losses pale in comparison to losses suffered when a project is financed almost exclusively from a project promoters coffers. The high debt-to-equity ratio shifts the risk of project failure to debtholderssophisticated multilateral lenders. 227 B. Use of Stand-Alone Project Company Special purpose entities (SPEs) provide a key element of project finance transactions. 228 The rationale is straightforward. In the vast majority of cases, project sponsors are experienced developers with consistent and expert global engagement in project finance transactions. 229 SPEs allow prolific project sponsors to obtain financing for numerous projects without such debt appearing on the balance sheet
224. See Bjerre, supra note 17, at 43637 (noting that project finance occupies a space somewhere in the middle of the consensuality spectrum, where the consensuality is unclear); Laplante & Spears, supra note 83, at 83 (noting that many efforts to include community consultation in the development process were seen as risk mitigation strategies that offered few meaningful opportunities for community participation). 225. See Duong, supra note 17, at 75. 226. Katharine C. Baragona, Part TwoBuilding Up to a Drawdown: International Project Finance and PrivatizationExpert Presentations on Lessons to Be Learned, 18 TRANSNATL LAW 139, 145 (2004). 227. See ESTY, supra note 3, at 3. 228. See Marcks, supra note 104, at 321 (noting that sponsors limit liability through formation of a project company, and that sponsors that want to mitigate the human rights risk would be advised to incorporate their project company[.]). 229. See, e.g., Likosky, supra note 16, at 67 (noting that many of the parties involved in project finance are repeat actors, engaged in a variety of transactions across the world).
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of the project sponsor or affecting the sponsors ability to obtain its own financing or engage in other development projects. This parent-subsidiary structure also protects the SPE by preventing contamination of the SPEs financial status by the sponsors other liabilities. SPEs are bankruptcy remote entities, which means that a parents bankruptcy will not affect the SPEs operations. 230 These entities also allow the sponsor to minimize exposure to risk, including environmental and human rights risks associated with the project, because the sponsor does not participate directly in the project. All financing, development, operation, and maintenance are handled through the SPE. 231 C. Non-Recourse Financing The availability of non-recourse financing provides project sponsors a key incentive in project financing. As previously discussed, in the classic form of project finance transactions, loans are extended on a nonrecourse basis, which means that in the event of default the lenders recourse is only to the assets of the project itself, not the assets of the project sponsor. Such financing does not appear on the sponsors financial statements unless the sponsor and financial auditors view the investment as material to the sponsors overall financial picture. 232 Nonrecourse financing thus provides project sponsors with the flexibility to invest in multiple, risky projects without any such project affecting its balance sheet. 233 In awarding financing, lenders evaluate the economic viability of the project to determine whether the key feature of project finance, the selffinancing aspect of the transaction, will indeed be realized throughout the life of the loan. Lenders therefore scrutinize deal documents to determine whether risks have been adequately transferred to third parties or
230. HOFFMAN, supra note 108, at 86. 231. See Marcks, supra note 104, at 321. 232. Duong, supra note 17, at 7778. 233. As Professor Duong discusses, the passage of the Sarbanes Oxley Act of 2002 might limit the use of off-balance sheet transactions if off-balance sheet project finance transactions are deemed to be within the meaning of Section 401(a) of the Act, which, adding a new Section 13(j) to the Securities Exchange Act of 1934, now requires public companies to disclose all material off-balance sheet transactions, arrangements, obligations, and other relationships of the issuer with unconsolidated entities. See id. at 78 (quoting 15 U.S.C. 78m(j) (2011)). In addition, she notes, according to Securities and Exchange Commission guidance, off-balance sheet arrangements include Variable Interest Entities (defined by FASB Interpretation No. 46) as contractual, ownership, or other pecuniary interests in an entity that change with changes in the entitys net asset value. Id. at 7879. Professor Duong further notes that the changes to the Securities Exchange Act of 1934 incorporated by the Sarbanes Oxley Act of 2002 were meant to catch egregious cases such as Enron, where the corporation incorporated special purpose entities (SPEs) to conduct illicit activities, and such cases are completely distinguishable from legitimate SPEs set up in accordance with a host countrys legal requirements for the specific purpose of conducting a [foreign direct investment] overseas, which by virtue of its NonRecourse Financing structure, may enjoy legitimate off-balance sheet accounting treatment. Id. at 79.
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assumed by project participants that are best able to absorb the risk. 234 As Professor Wendy Duong notes in her case study regarding a power project in Vietnam, lenders react to untreated or uncovered risk of loss by turning down requests for financing or by requesting additional collateral support for the loan. 235 These fiercely negotiated contractual arrangements give lenders the comfort required to extend loans on a nonrecourse basis. The resulting contractual framework for cross-border project finance transactions is one of the most complex and extensive of any type of financial arrangement. 236 Under most loan documents, in the event of default, the agent of the lending syndicate has the right to step into the shoes of the project company and protect its most valuable asset, the project itself. In some instances the loan is extended on a limited recourse basis, allowing for some encumbrance on the balance sheet of the sponsor. 237 The collateral, in most cases, consists of any project contracts and the physical assets of the project, thereby further isolating the sponsors assets from the activities of the project. As such, during project negotiations, significant energy goes into developing a cross collateralization framework that allows the lender to take over the project if the project company defaults on its loan. The other recourse available to the lender is to obtain possession of and operate the project. This allows the lender to maintain the operation of the project, thus increasing the likelihood that the asset will generate income to service the outstanding debt. While some empirical studies point to a trend toward limited recourse financing to provide lenders with additional collateral in the event of a default (e.g., the assets of the sponsor), the trend in project finance remains closely linked to non-recourse financing. 238 D. Risk Shifting in Project Contracts To borrow a property law analogy, project finance transactions are composed of a bundle of risks. As Scott Hoffman notes, contracts form the framework for project viability and control the allocation of risks. 239 Contract serves as a critical risk mitigation mechanism within the overall risk mitigation mechanism of project finance. 240 Under general contractual principles, risks are shifted to parties best able to bear
234. Id. at 7576. 235. Id. at 76. 236. Id. 237. Id. at 75. The La Mata-La Ventosa wind project contains this feature. According to a program officer, the project contains limited recourse debt that will quickly convert to nonrecourse debt during the course of the project. E-mail from Jefferson Boyd Easum, supra note 52. 238. LIKOSKY, supra note 114, at 20. 239. See HOFFMAN, supra note 108, at 7. 240. See id. at 27; Marcks, supra note 104, at 320.
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them. 241 Usually this means that the parties who control the causal mechanism responsible for bringing the risk to fruition as a harm or loss also bear the contractual burden of the risk. 242 In a complex infrastructure development transaction, multiple causes may produce various risks within the project, and therefore the project company must disaggregate and isolate individual risks and their associated causation in order to distribute them through the project documents. As such, risk shifting becomes a key component of the project negotiations, which include identifying the party best situated to assume the risk and translating such risk into a premium paid by the party shifting the risk. 243 Scholars and practitioners engaged in project finance routinely identify two primary categories of risks with respect to infrastructure development: (1) commercial, or economic, risks, including (a) construction risks, which generally take the form of delays and cost overruns, (b) fuel supply risks, including price increases and supply shortfalls, (c) market risks, such as weak demand for output, lower prices for the project output, and changes in the exchange rate and inflation, and (d) operating risks, which include risks relating to the day-to-day operations of a project, such as environmental damage or regulatory interference; and (2) political risks such as government expropriation, currency inconvertibility, and war. 244 The foregoing risks are typically evaluated and incorporated into highly negotiated transaction documents. If these risks are not covered via risk shifting, the project developer will bear both the risks and associated costs. The following sections outline the key mechanisms utilized to diffuse the two primary categories of risk commonly associated with infrastructure development. 1. Commercial Risks The key commercial risks are risk of construction delay and operational risk. Construction delay is the death knell of a project finance transaction reliant on the income generated by the project under construction, and is the most frequently referenced commercial risk. The party best able to absorb the risk of delay is the EPC Contractor. The project company passes along any construction-delay risks to the EPC Contractor as reflected in the financial terms of the fixed-price, turn-key, EPC Contract. The EPC Contractor then completes the construction, bearing any costs associated with delay. The project company pays the EPC Contractor a premium to absorb the risk associated with a delay,
241. Duong, supra note 17, at 82. 242. John G. Mauel, Common Contractual Risk Allocations in International Power Projects, 1996 COLUM. BUS. L. REV. 37, 41 (1996). 243. Duong, supra note 17 at 82, 84. 244. Mauel, supra note 242, at 42.
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and thereby shifts the risk of delay to the contractor and away from the project company. When the project company or operations and maintenance contractor receives the keys to the project, the EPC Contractor may walk way from the project, save the honoring of various warranty obligations. 245 Performance difficulties in the project fall into the category of operation risk. The party to whom such risks are shifted is the O&M Contractor. The O&M Contractor oversees the daily operations of the plant, and is therefore well situated to control factors that may lead to performance difficulties at the plant. Accordingly, the project company shifts operation risks to the O&M Contractor via the terms of the O&M Contract. In each of the foregoing cases, the party absorbing the risk is paid a premium for accepting it. 2. Political Risks Political risks generally fall into three categories: expropriation, currency inconvertibility, and war. Project companies have become quite adept at obtaining political risk insurance 246 to cover the risk of government expropriation of a project or political unrest. Both the buildown-operate-transfer (BOOT) and build-operate-transfer (BOT) models also effectively displace expropriation risks associated with risky development projects, because they are structured to provide for the eventual public take over of the project. 247 To avoid currency-related risks, the project company has several options. It may designate a purportedly stable currency, such as the U.S. dollar, as the dominant currency for the transaction. To create stability within the transaction, the Offtaker and project company may agree to use a certain exchange rate throughout the course of the transaction to avoid significant variations in the revenue generated by the project and to provide comfort to lenders regarding the projects ability to service the debt. 248 If availability of currency poses a threat, the project company establishes an offshore account with a certain amount of the required currency and requires that the Offtaker maintain the currency at certain
245. See Duong, supra note 17, at 87. 246. Political risk insurance is a crucial component of modern project finance transactions; however, a comprehensive discussion of its ability to induce risky behavior exceeds the scope of this article. 247. In the build-operate-transfer (BOT) form of project finance the private developer builds the project and operates the project for fixed amount of time to provide for debt service and the required investment return prior to transferring the project to a public entity. See Estache & Strong, supra note 2, at 3. 248. See Duong, supra note 17, at 75.
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levels within the account until the project debt is paid. 249 These risk mitigation tools allow the project company to better manage the most precious commodity at stake in a project finance transaction: the revenue stream. Moreover, as illustrated in Part IV, they combine to create an environment where certain risks are passed on to third parties. VI. PROJECT FINANCE AS A RISK INDUCEMENT MECHANISM High debt-to-equity ratios, SPEs, non-recourse financing, and contractual risk shifting are standard features of project finance transactions, all accompanied by explicit risk-shifting rationales that primarily fall into economic and political risk categories. With few exceptions, 250 absent from the literature is a robust discussion of the risk of social and environmental externalities that exist at the outset of a project and the corresponding risk mitigation techniques that are employed by project developers to displace such risks. What is not discussed is that these risks are also handled structurally via the project finance form; however, the parties ultimately bearing such risks are not parties to the transaction structure, and therefore receive neither premium nor compensation for bearing them. This cuts against the assumption that project finance provides a neutral framework to finance infrastructure. Moreover, it subverts the dominant law and economics framework that underpins contractual risk management and the market efficiency principles promoted in the development discourse. Even more fundamentally, however, it actively undermines social justice. Project sponsors utilization of the project finance framework to shift risks away from themselves, as well as to externalize effectively the negative outcomes that typically accompany large-scale projects, is a unique feature of modern-day infrastructure development that prominently features non-state actors. Indeed, as Professor Lissa Lamkin Broome reminds us, one reason public infrastructure was formerly provided by either government-owned enterprises . . . or by privately owned utilities subject to rate of return regulation, was because of the existence of [e]xternalities whereby benefits and costs are conferred upon those not a party to the transaction. 251 In other words, in the past, the unique effects of large-scale public infrastructure projects were explicitly acknowledged in the finance form. Public financing was
249. See Smith & Htoo, supra note 16, at 222. 250. Notable exceptions include and Bjerre, supra note 17; Broome, supra note 17; Likosky, supra note 16. 251. Broome, supra note 17, at 443 (quoting Darrin Grimsey & Mervyn K. Lewis, Evaluating the Risks of Public Private Partnerships for Infrastructure Projects, 20 INTL J. PROJECT MGT. 107, 108 (2002)).
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preferred because of a host governments unique ability to mitigate negative externalities and absorb the risks associated therewith. Project finance subverts this explicit acknowledgement, purports adequately to distribute all known risks on those parties best able to absorb them, but ultimately shifts unaccounted-for negative externalities onto third parties. The following discussion illustrates that certain additional risks namely the social and environmental externalities associated with infrastructure developmentare in fact never fully borne by the project sponsors, but are disproportionately borne by third parties who are not parties to the transaction. 252 Because they do not have to bear the risk of their activities, the risk diffusion mechanisms could actually operate to induce risky behavior on the part of project sponsors. Although there could be other mechanisms within the project finance form that mask and displace risk, we examine the four key risk diffusion mechanisms already outlined to gain a deeper understanding of how risk could be induced. A. Low Initial Capital OutlayPassing on the Risk of the How As previously discussed, project finance is attractive to investors because it permits investors to invest relatively little at the outset. Lenders recognize the relationship between the commitment to the success of a project and equity outlay; however, project sponsors are incentivized to commit as few funds as possible in order to reduce the amount of their capital that is in jeopardy throughout the course of the project, and leave more cash available to fund other projects. The high debt-to-equity ratios that characterize project finance transactions are typically labeled as economic risk diffusion mechanisms, but they go further, ultimately forcing communities, rather than sponsors, to bear the risk of a projects failure resulting from the externalities it produces. Therefore, this mechanism could be viewed as something morea social and environmental risk diffusion mechanism. A classic project finance transaction permits an investor to contribute its limited equity and then take a relatively passive role throughout the lifetime of the project. The investors primary concern in this arrangement is realizing a return on his investment. The investor is less concerned with how the project manifests itself because even if the project fails the investors relative contribution is 10% to 30% of the overall project cost. The how concern is passed on the lenders, who have, arguably, very little interest, other than reputational risk, in seeing that a project limits its social harm. If equity investors had more at stake, they
252. This liability limiting carries significant weight in the project finance development context, where the rules of the transaction are created by a complex contractual framework that lacks transparency and the potential harm to third parties touches on intimate aspects of such parties lives.
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could be more likely to take an interest in the how of a projects manifestation, and therefore might more actively participate in the mitigation of negative externalities associated with the project. Without this incentive, however, investorsthe actual owners and promoters of a projectassume a passive role that relegates the concern of the how to a lender problem. With the how of a project squarely a lender concern, the risk of externalities inevitably becomes a community burden. The Equator Principles, adopted in 2003 by a group of nine international banks and the IFC, illustrate this effect. The Equator Principles, ten short guidelines related to the social and environmental oversight of projects financed using project finance, 253 aim to create a lender standard with respect to project lending. They are based on an implicit recognition that project finance participants do not properly manage environmental and social risks, and that such risks are common features of project finance transactions. 254 Lenders who sign on to the Equator Principles agree to incorporate the principals into bank policies, 255 and presumably work to enforce the standards in the projects they finance. The principles have been critiqued as vague and unenforceable, 256 and actual evidence in the Camisea pipeline development in Peru, where the Equator Principles figured prominently in the project finance transaction, 257 also suggests that these lender-based efforts at shoring up risks may have failed. 258 This evidence raises a significant concern regarding the management of social and environmental risks associated with project finance. If lenders, suppliers of 70% to 90% of a projects debt and parties to highly negotiated loan agreements containing covenants that require the project company to manage social and environmental risks, are unable to affect the management of projects, the project lacks an internal backstop to limit the externalization of these risks. Risk on the ground level of the project therefore goes unchecked, and sponsors, with little skin in the game, never bear the risk of the projects activities. Indeed, when failures occur, as evidenced by the serious environmental and social externalities
253. See THE EQUATOR PRINCIPLES, THE EQUATOR PRINCIPLES A FINANCIAL INDUSTRY BENCHMARK FOR DETERMINING, ASSESSING, AND MANAGING SOCIAL AND ENVIRONMENTAL RISK IN PROJECT FINANCING, available at http://www.equatorprinciples.com/documents/Equator_Principles.pdf. 254. See THE EQUATOR PRINCIPLES, ABOUT THE EQUATOR PRINCIPLES, available at http://www.equator-principles.com/documents/About_the_Equator_Principles.pdf (noting that [f]or a number of years banks working in the project finance sector had been seeking ways to manage the environmental and social risks associated with [project finance] and that the group jointly developed a framework for addressing such risks). 255. See id. 256. See Robert F. Lawrence & William L. Thomas, The Equator Principles and Project Finance: Sustainability in Practice?, 19 NAT. RESOURCES & ENVT 20, 26 (2004). 257. See LIKOSKY, supra note 114, at 119. 258. See Bowen, supra, note 91, at 73738.
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produced in the Camisea case, the externalities are absorbed at a communal level. 259 Changing the capital structure could impact this outcome. By giving the equity investors a bigger stake in the project at the outset, some of the risk of the social and environmental harms could be retained by project sponsors, the parties with more control over project design and management. Arguably, sponsors would be more likely to take an interest in the how of a projects manifestation, and therefore might more actively participate in the mitigation of negative externalities associated with the project. Without this incentive, however, investors assume a passive role that relegates the concern of the how to a lender problem. Lenders understand this dynamic, which is why they aim to balance the needs of the investor with the needs of the project by sometimes requiring lender consent prior to a change of control of project ownership. 260 Host governments also recognize this dynamic, and in some cases they require certain debt-to-equity ratios. Without a proper check on this aspect of project finance, however, the equity investors avoid a significant aspect of managing large-scale infrastructure risk. The risk of the how therefore ultimately falls on the backs of third parties who will never realize a financial return. It could be argued that the sponsors equity investment faces the most risk at the beginning of the project, prior to the commercial operation date, when vulnerable projects are more likely to fail and produce externalities. Therefore, this reasoning provides, such investors are more likely to act rationally in the face of risk, safeguard the project, and minimize effects on third parties. This argument has some merit, but it fails in two respects. First, a standard equity contribution relative to the overall cost of a project is minimal. Sponsors may be concerned about their investments, but the project finance capital structure takes the overall burden of project failure off of sponsors. This explains the intricate contractual maneuvering among the lenders, sponsors, and host governments throughout the project structure. All parties understand that in terms of relative capital, the project sponsors have the least at stake. 261 Second, the equity contribution does not exist in a vacuum. It represents one component in a highly negotiated mechanism that diffuses and displaces
259. See id. at 738 (noting pipeline spills, harm to waterways, and damage to ecosystems). 260. See HOFFMAN, supra note 108, at 327 (If the project sponsors were to sell all or a substantial portion of their investment in the project company, it is possible that they would be more likely to abandon a project or not otherwise support it if financial or other problems arise.). 261. Estache & Strong, supra note 2, at 15; ESTY, supra note 13, at 25.
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risk. Taken as a whole, the mechanism also yields externalities. I turn now to the remaining components of the form. B. The Special Purpose EntityObfuscating the Who In The Death of Liability, 262 Professor Lynn LoPucki discusses the movement away from liability and accountability in society towards something more amorphous in which corporate actors are never held liable for their actions. It is an extreme view, but in making this argument, Professor LoPucki analogizes corporate liability to a poker game, in which the players, economic actors, contribute chips to the pot. Such chips are taken in order to satisfy liability, but even players who dont put any chips in the potthat is, players who are judgment proof can keep playing the game and are eligible to win. 263 He analogizes further, stating that [s]oon no one will have significant chips in the pot. When that happens, the fundamental nature of the game will change. Liability will die. 264 In project finance transactions, where the SPE limits a project developers chips in the development game, liability is very close to dead. The sole purpose of the project finance SPE is to develop the project. Large-scale infrastructure projects may cost billions of dollars; impact the public in significant ways; and require the SPE to contract with financial institutions, construction companies, suppliers, and power purchasers. 265 The scope of infrastructure projects is broad, and the impacts are deeply felt throughout the communities in which such projects are developed. The SPE, however, lacks substance, reputation, or incentive to engage in sustainable business practices. If the project fails, the lenders take over the project and the SPE simply goes away. Save a loss of their initial equity investment, the project sponsors do not feel the full impact of project failure, and are permitted to continue engaging in development activities through other special purpose vehicles, sans penalties. 266 Moreover, the SPE absorbs all of the risks of the project before contracting them away. Even if a SPE commits a foul throughout the course of development, the same principles of remoteness that characterize securitization make it difficult for affected third parties to reach the actors better able to prevent externalities from occurringthe
262. LoPucki, supra note 22. 263. Id. at 3. 264. Id. 265. See HOFFMAN, supra note 108, at 71. 266. See Duong, supra note 17, at 104 (explaining that project failures do not reach the project promoters assets, and that in the event of failure, the citizens of the capital exporting company feel the impact of the losses when loans are defaulted, and citizens of the Third World also feel the impact because they must pay the project debt without the benefit of the infrastructure).
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project sponsors. The project sponsors therefore shift the risk onto an entity that, in substance, resembles the air. It is simultaneously elusive, pervasive, and yet, ultimately invisible. The risk of real damage therefore falls on third parties who never agreed to the project or the structure thereof, and who lack access to a SPE-tortfeasors assets due to the allassets liens that are standard in project finance transactions. The La Ventosa projects demonstrate some of the difficulties faced by those seeking redress for land and environmental harms caused by the development. The Isthmus is the site of no fewer than fourteen separate development projects. On a basic level, local residents must first determine the who behind these various developments. Often, the who is the EPC Contractor, who has negotiated a price to deliver the project by a date certain; the SPE; or in the case of the La Mata-La Ventosa project and the land leases entered in connection therewith, related entities that exist far down the corporate food chain from the project sponsor. With language barriers and no access to the land contracts that are the subject of dispute, navigation of this web of entities is daunting at best. The absence of a who that may be engaged makes access to justice difficult, if not impossible. The project finance form contributes to this obfuscation. The SPE further diffuses risk as to the project sponsors because the project may fail, but any failures related to the project do not affect sponsors financially 267 or reputationally. 268 Recall that the project finance SPE owns nothing other than its contracts and the project assets. In failing, the project may result in significant losses to the environment or the social fabric of a community, but given that the SPE was formed solely for the development of an isolated project, if the project fails, project losses are not borne by the SPE. Instead the community is left in the wake of any project damage, with claims against a virtually judgmentproof entity that is a mere vessel of its contracts and liabilities. C. Non-Recourse LoanKeep the Income Stream Flowing With respect to the actual financing of the transaction, through the non-recourse loan funding process, the project company must make the case to lenders that the project will produce enough income to service the
267. See Duong, supra note 17, at 78. 268. See ESTY, supra note 13, at 12 (Reputation plays a very limited role in project finance. At the sponsor level, reputation effects are nullified by the nonrecourse nature of project loans; reputation is only a factor for sponsors that repeatedly enter the project finance market. At the project level, reputations do not exist because most projects are greenfield entities.). This reputational behavioral paradigm is also evident in the securitization market that fueled much of the systemic failures related to the global financial crisis. See, e.g., Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, 1706 PLI/CORP 307, 313 (2008) (noting that thinly-capitalized loan-originators have reduced reputational risk, and operate with low capital and participated in the subprime market by capitalizing on their ability to shift risk).
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project debt and obviate the need for providing additional collateral to support the loan. 269 The project company may not obtain financing without proving to the lender that it has adequately distributed the risks of the project throughout the transactional structure. In essence, the project company must show that the project itself is virtually risk-free with respect to delivering a fully constructed facility that is capable of consistently generating revenue. As a result, the project company must demonstrate that it has adequately shifted any risk of disrupting the income stream away from itself and onto a third party or other project participant better able to absorb such risk. In this process, the project company is incentivized to maximize the projects revenue, but in fact bears no burden for such revenue maximization. The non-recourse loan is the reward for effective risk diffusion. Such loan does not appear on the sponsors balance sheet or affect its assets. Scholars note that without the incentive of off-balance sheet financing, project sponsors would be reluctant to invest in risky infrastructure projects of the Global South absent a high profit margin. 270 Indeed, sponsors work exceedingly hard to structure deals that rely on the purest form of classical non-recourse financing. As Professor Wendy Duong notes, [t]he end result is evidentthe high-risk, Third World development project in question will leave no effect [on a project sponsors] assets, credit, or balance sheet. 271 The implications of this type of financing are troubling. Both the project sponsor and project company have a real incentive to complete the project and generate a revenue stream for debt service, but with non-recourse financing, the risk of failure is substantially borne by the lenders and third party tort claimants. As previously discussed, the security agreement of the transaction will treat the project assets and contracts as collateral, simultaneously leaving little collateral for thirdparty tort claims. 272 Admittedly, such assets are not cheap, but they are financed in large part by the project debt. To a project sponsor, therefore, the reverberations of a project failure ring hollow. The risk of failure does little to affect the sponsors bottom line, but success could mean a
269. See YESCOMBE, supra note 128, at 106 (noting that project lenders want the project company to structure transactions to avoid disputes regarding a failure to construct the project correctly); Duong, supra note 17, at 83 (noting that risks to the revenue stream must be contractually allocated). 270. See Duong, supra note 17, at 80 (noting that [u]nless Non-Recourse, Off-BalanceSheet Project Financing is available, the corporate investor is reluctant to take on high-risk FDI transactions in faraway lands or on foreign territories with political and legal concepts alien to the U.S.-trained business executive or lawyer.) 271. See id. at 7778. 272. This treatment was consistent in the Oaxaca transactions, where lenders received standard collateral packages. See E-mail from Rachel Robboy, supra note 47; E-mail from Jefferson Boyd Easum, supra note 52.
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substantial payout. In actuality the project company also loses no real skin in the game, because its sole purpose is the development of the project. Other than what it creates as a result of the project, it has nothing else at stake. What then, is the project companys objective in delivering the project? Generating a revenue stream that pays down the debt and eventually allows the sponsors to cash out of the project. This dynamic permits the project company to ignore certain social and environmental risks at the outset of the development because, effectively, it absorbs none; any assets at stake were paid for by non-recourse debt. Such risks do not lapse, but are absorbed by the community in which the development is housed. This community, a group of tort-claimants without access to the sponsors deep pockets and with no ability to control development outcomes, bears these burdens with none of the lucrative benefits that await the sponsors. The wind development in El Istmo bears this out. Indigenous communities rely upon the land used for the various wind projects to support a subsistence way of life. Once a resident agrees to permit a windmill on his or her property, the land is disrupted, as is such residents connection thereto. A portion of the property is affected by the soil unearthed by the digging for the turbines. The water table is changed by the cement that supports the turbines. If a wind project succeeds, it generates electricity that will be sold to a private company. The proceeds of the sale will flow to the project company to service the project debt and, eventually, the sponsors will receive a return on their investment from any residual proceeds. If a wind project fails or substantially harms the community, the project company goes away, but residents remain affected by the turbines, their impact on the environment, and their affect on the residents ability to maintain their lifeways. This displacement of risk is promoted by the project finance structure, which isolates the assets of the project promoter, places a comprehensive lien on the projects assets through non-recourse lending, and leaves third parties, such as the rural farmers in Oaxaca, with few viable options. The non-recourse feature of project finance further promotes a devilmay-care attitude with respect to accountability for such risk shifting. As long as the project produces a revenue-stream, the partiessponsors, the project company, and lendersreap the benefits. Even in a worst-case scenario, where affected parties are able to limit or halt the development, the project sponsor has no assets at stake and the project company, the SPE, eventually walks away through a liquidation of its assets. The community, however, cannot walk away, and is left with an asset-poor SPE against whom to direct latent tort claims. The community absorbs the harmful effects of the development, even though such harms are outside of the communitys control. This outcome subverts risk-shifting
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principles, and turns the notion of neutrality of the financing form on its head. This method of finance is not neutral; the structure of project finance transactions produces tangible effects for third parties. Indeed, as Professor Duong notes, [t]he use of Project Financing as the corporate sponsors risk-allocation mechanism is fatally flawed because it ultimately protects the corporate sponsor, the party who is in the best position to assess future risks of loss, and who benefits the most from the financial reward of the project, all to the detriment of those whom the project is supposed to serve. 273 D. Risk Shifting in Project ContractsPassing the Buck In the development context, the extensive documentation of project finance transactions provides the legal framework for the deal. Project finance, to put it simply, is the law. 274 This creates a precarious situation for third parties, given that the predominant neoliberal philosophy puts the interests of the firm ahead of non-party stakeholders. 275 Further, the sheer number of parties participating in a project finance transaction incentivizes the project sponsor to conceal risks and create a moral hazard. 276 I have already discussed the mechanisms available to project companies to distribute known political and economic risks and noted that very rarely does the prevailing literature acknowledge that social and environmental risks also exist at the outset of a project and are therefore also distributed. These risks are sometimes labeled generically, political risks, 277 and are masked throughout the transaction structure, ultimately to be borne by parties that are conspicuously absent from the negotiating
273. Duong, supra note 17, at 105. 274. In the case of the Chad-Cameroon pipeline, one of the largest projects affecting the African continent, Amnesty International notes that, [a]ccording to the [project] agreements, where national laws and regulations conflict with the terms of the agreement itself, the agreements are declared to prevail. AMNESTY INTERNATIONAL, CONTRACTING OUT OF HUMAN RIGHTS: THE CHAD-CAMEROON PIPELINE PROJECT 22 (2005), available at http://www.amnesty.org/en/library/asset/POL34/012/2005/en/76f5b921-d4bf-11dd-8a23d58a49c0d652/pol340122005en.pdf. Efforts at standardizing project finance transactions appear limited to individual state statutes. See Catherine Pdamon, How is Convergence Best Achieved in International Project Finance?, 24 FORDHAM INTL L.J. 1272, 1277 (2001). The United Nations has also set forth extensive legislative guidelines for project finance. See GENERALLY UNITED NATIONS COMMISSION ON INTERNATIONAL TRADE LAW, LEGISLATIVE GUIDE ON PRIVATELY FINANCED INFRASTRUCTURE PROJECTS (2001), available at www.uncitral.org/pdf/ english/texts/procurem/pfip/guide/pfip-e.pdf. Sophisticated players, however, rely on their own boilerplate documents to provide most of the transactional template. See Pdamon, supra, at 1294. See also Lawrence & Thomas, supra note 256, at 21 (noting that given the environment for project finance transactions, it is not uncommon for the project documentation to form the principal legal framework for the transaction); Stephen J. Choi & G. Mitu Gulati, supra note 82, at 1130 (arguing that boilerplate contractual language should be viewed as statutes). 275. Yelpaala, supra note 107, at 3334. See also LIKOSKY, supra note 114, at 15657 (noting that globalization is held in place by a system of legal rights that promotes capital accumulation to the detriment of millions of people). 276. Yelpaala, supra note 107, at 77. 277. See HOFFMAN, supra note 108, at 100.
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table. Let me begin at the debt level. Despite the recent movement toward increasing the specter of accountability on the part of lenders, private lenders have little incentive or ability to encourage project companies to adhere to strict human rights standards. 278 From an economic perspective, such adherence would increase the economic burdens borne by the project, reduce the revenue stream available to pay down project debt, and could put the borrower in a default situation. 279 From a practical perspective, lenders are not the parties best situated to manage social and environmental externalities of large-scale projects. Absent lender enforcement of strict guidelines relating to human rights or the environment, project companies lack economic incentives to do so. The parties best positioned to manage social and environmental risks might also lack real incentives to do so. The EPC Contractor, as the contractor on the ground responsible for building the project, is in the best position to control negative outcomes concerning the construction of the project; however, since the EPC Contractor is paid a premium to avert construction-related delays, it too has little economic incentive to mitigate externalities by incurring additional costs (e.g., developing and implementing an extensive plan to prevent and manage externalities). The risk of externalities therefore slips through the contractual gaps of the transaction and becomes a thirdparty concern. This does not suggest that such risk-shifting is accompanied by intent; the transactional structure simply permits it. 280 When the project is fully constructed, it is delivered to the O&M Contractor, who manages the day-to-day operations of the project. The O&M Contractors motivations are similarly aligned to the EPC Contractor. The O&M Contractors primary goal is to maximize efficiency of the projects output and to avoid penalties related to delivering a second-rate product. A delay in producing the output could mean a delay in selling the output, which would likely lead to a disruption in the revenue stream and a delay in paying the creditors. In addition, the O&M Contractor would most certainly owe liquidated damages to the project company. This structural aspect of project finance requires singlemindedness on the part of the O&M Contractor. It also incentivizes a party with significant control over project, the O&M Contractor, to
278. See Bowen supra note 91, at 741 (discussing failure of Inter-American Development Bank to enforce social and environmental standards in the Camisea project). 279. Lawrence & Thomas, supra note 256, at 22. 280. Cf. ESTY, supra note 13, at 29 (discussing the separate incorporation feature of project finance, noting that such feature shields risk averse managers in sponsoring firms from bad outcomes at the project level more effectively than corporate finance and that while managers do not often publicly admit to using project finance for this reason, they will more readily admit to this concern in private conversations.).
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externalize certain of the risks by avoiding the costs of their management. 281 Project participants might counter the suggestion that the contractual mechanisms that characterize project finance transactions allow the risk of social and environmental externalities to slip through the cracks by arguing that the opposite is true. Principles of economic efficiency, they might suggest, in fact incentivize all actors to hew closely to the highest of environmental and social standards to increase the likelihood of the projects success and the eventual payment of each party to the transaction. This argument would be more convincing if the success of projects did not so closely rely on the rapid production of an income stream to flow through the project to all project participants. At every level of the project structure, the incentive is to streamline the process to allow for construction and eventual commercial operations. Any deviation from this goal is inefficient. Taking the Oaxaca private wind projects for example, the land, social development, and bird migration issues certainly arose throughout the course of development, but the transactions reached financial closing. The problems remain: The are mere externalities to lucrative wind developments. This suggests that there may be a ceiling of externalities beyond which point projects fail. 282 The project finance form incentivizes actors to push this ceiling. 283 VII. OVERCOMING STRUCTURAL DEFICITS As the foregoing discussion illustrates, project finance bundles and diffuses risks throughout projects and passes such risks on to third parties who are not parties to the transaction. In doing so, the project finance mechanism permits project sponsors to approach host governments with the following implicit bargain: If you, host country, want this investment, you must make it easy for me to get the deal done. You absorb the environmental and social risks. I absorb the financial risk. But my financial risk is diffused throughout the finance structure to facilitate a higher return on my investment. Your environmental and social risks are passed on to the community. We both win. To affected third parties, the
281. An extreme example of this occurring is the Dabhol case, in which a contractor of the project developer allegedly harassed and intimidated those opposed to the project. See supra note 102. 282. This is an empirical question, and the subject of a future project. As noted at supra note 16, the true costs of project finance-based development are difficult to quantify. Understanding the relationship between the costs (e.g., externalities produced) and benefits of this transaction model is beyond the scope of this article, but raises an interesting question regarding whether the benefits of project finance form ever outweigh its costs, which are often difficult to measure. 283. A useful illustration of this point is the establishment of the Equator Principles, which, as some have pointed out, were established to level the playing field, and establish a minimum standard to which the major project financing lenders would adhere. Lawrence & Thomas, supra note 256, at 22. Arguably, this framework is of little effect today; with and without it, project developers, acting within full view of lenders, push the limits of risk to maximize profits.
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project sponsor enters the development scene stating: We will bring investment to you, but you, and your people, must bear the risk of externalities associated with the project. Otherwise, this investment is too risky, and therefore not financially viable. 284 The legal framework created by project finance facilitates this attenuation of risk. In critiquing Professor Carl Bjerres discussion of third-party consensuality to project finance transactions, Professor Stephen Wallenstein argues that:
From the perspective of third parties, there is nothing unique to building power and transportation projects in emerging markets, as opposed to shopping malls, industrial complexes or office building in the United States, through conventional corporate financing. Third parties may consent or object to business activities occurring in society, but the government regulates them all. This is not a unique problem of project financing, and indeed these same negative effects can occur as a result of a securitization. 285
Professor Wallenstein is correct. The problems associated with development follow all financing forms. What Professor Wallenstein neglects in his discussion is that project finance is extreme in its treatment of risk. Indeed, the legal framework produced by the form intentionally creates an environment where risk is actively bundled and diffused. Rational actors would not opt for the complexity and high transaction costs of the project finance framework unless such structure provided an added benefit. 286 Therefore, there must be something imbedded in the project finance form that makes it more attractive. 287 As this article illustrates, project finance provides an added economic benefit in that sponsors may diffuse the risks associated with infrastructure development while avoiding absorption of the externalities
284. In his discussion of the danger of utilizing limited liability companies in the project finance context, Professor Jonathan R. Macey notes that limited liability allows investors to pursue extremely risky projects and to profit from the pursuit of a heads I win; tails you lose strategy of project finance. The members divide the spoils of risky or dangerous projects that turn out well, while the costs associated with projects that turn out badly are largely borne by creditors and innocent tort victims. Jonathan R. Macey, The Limited Liability Company: Lessons for Corporate Law, 73 WASH. U. L.Q. 433, 448 (1995). Moreover, as Professor Macey points out, economic theory would predict that the emergence of the limited liability company will raise the level of risk-taking beyond its previous levels . . . . [and] much of this new risktaking will be suboptimal from a societal perspective, because the people making the decisions to pursue these risky activities are not going to bear the full costs of the damages they impose others. Id. at 449 (emphasis added). 285. Stephen Wallenstein, Situating Project Finance and Securitization in Context, 12 DUKE J. COMP. & INTL L. 449, 451 (2002). See also HOFFMAN, supra note 108, at 100 (stating that the social effects of project finance infrastructure projects are more accurately labeled as political risk and should in no way be viewed as unique to project finance.). 286. ESTY, supra note 13, at 27 (suggesting that the risk management can be value enhancing in project finance). 287. Id. at 2 (noting that for project finance to be rational, [it] must entail significant countervailing benefits to offset the incremental transaction costs and time.).
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produced. Thus, while it is true that third parties are no more present at the bargaining table in a project finance transaction than a corporate finance transaction, this absence is exacerbated by the externalization of risk that characterizes the form. Such problems are not problems of a political or democratic nature, 288 but are of a fundamental, transactional nature, best resolved by modifications to the form itself. Faced with a form that contains these structural flaws, one might be tempted to do away with project finance altogether; however, given the current infrastructure landscape and the prevalence of the form, a wholesale rejection of project finance is unlikely. We can, however, examine the impact of small changes on a case-by-case basis and urge for host government adoption of laws that modify some or all of the risk mitigation features of this type of foreign direct investment. We begin with the abrogation of the non-recourse financing mechanism. A. Eliminate Non-Recourse Loans Under a traditional corporate finance rubric, a lender typically has recourse to all of a project sponsors assets and revenues. 289 Until the 1980s, this was the dominant mechanism used to finance energy projects. 290 As Dr. Hossein Razavi of the World Bank notes, lenders (in particular commercial banks) took comfort in knowing that repayment of loans came from the parent entity and was backed by the entitys entire balance sheet. 291 Modern-day large-scale infrastructure projects could follow this model, the logic being that if lenders require more upstream collateral, sponsors will be more engaged and more likely to care about the how of a project. Collateral could take the form of sponsor to lender guarantees that live throughout a projects lifetime, or lender liens on certain of the sponsors assets. Opponents to this approach could argue that including such encumbrances on a sponsors balance sheet might make sponsors less likely to engage in risky infrastructure development projects and thereby reduce the amount of capital available in riskier development contexts. Using the same rationale, however, one could counter that by putting more of a sponsors assets at risk in risky environments, the sponsor will be prudent in minding the store. This could lead to more careful development, and force the sponsor to bear more of the risk of development rather than shift risk to a SPE that exists solely for the purpose of developing the project. Moreover, sponsors might take more care in selecting projects. If a
288. 289. 290. 291. Cf. HOFFMAN, supra note 108, at 100. Duong, supra note 17, at 75. See RAZAVI, supra note 114, at 251. Id.
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large-scale project carries with it the known potential to create devastating social and environmental harms, a project sponsor whose assets are on the line might be more deliberate in mitigating the potential negative effects of a project or decide to forgo the development altogether. Understanding that it does not have the shield of nonrecourse financing to separate its assets from any potential defaults (e.g., from environmental issues or social unrest arising from the project) that could result from disruption on the ground might push a sponsor to think more fully through the potential implications of a project and be more prudent in assuring proper management of the project through the SPE. This type of hesitation would greatly serve the communities in which such potentially harmful projects are located. Recourse financing would force the project sponsor to absorb more of the social and environmental risks of the project, and this makes sense; the sponsor, with its deep pockets on the line, is in the best position to control such risk. B. Lower Debt-to-equity Ratios High debt-to-equity ratios permit sponsors to shift the majority of the financial burden of a project to the lenders, whose main objective is ensuring that the project is contractually prepared to deliver the debt service in a timely fashion. This arrangement also allows the sponsor to fade into the background with respect to project oversight. With a relatively small investment at stake, the concern that a project may cause displacement or environmental harm falls on the lenders. Since the lenders oversight of the project is primarily financial, and not managerial, they rely on the project company to hedge such operational risks. 292 However, when a lender evaluates a facilitys operations, it lacks the incentive 293 or expertise to ensure that negative social and environmental risks, especially those that do not affect the projects revenue stream, are adequately covered. The risk of negative externalities does not go away, but rather it is borne by third parties. Putting more of a sponsors initial investment at risk could change this dynamic. A higher equity outlay would increase the likelihood that the sponsor would remain engaged in the project a meaningful way throughout the lifetime of the project. Since the sponsor, as equity, gets paid last in the
292. See Bowen, supra note 91, at 740, 744 (noting that with the Camisea pipeline project in Peru, the Inter-American Development Bank relied too much on the project sponsor to provide for a community monitoring system that did not meet the [banks] standards[,]and the bank left a lot of day-to-day monitoring to the project sponsors[,] all of which resulted in significant harm to the environment and local community). 293. See Lawrence & Thomas, supra note 256, at 26 (noting that lenders lack incentives to monitor environmental performance in various areas of projects).
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line of creditors, with more at stake it might have more of an interest in ensuring that the business is operated in a way that guarantees that it realizes its return. The incentive to stay the course also makes it more likely that the sponsor, in a more active managerial role, would pay attention to a projects effects on the local community and environment. Without such an incentive, the sponsor is permitted to make its initial investment, and then cross its fingers with the hope that it eventually realizes a return. By changing the deal structure, the sponsor makes a long-term commitment to the projects success, thereby mitigating any harmful effects the project may have on the community in which it is located. Skeptics may argue that this type of financial convention would subvert commonly held risk management principles. To the contrary. The current form of project finance, absent additional equity requirements imposed by a host government or lenders, allows the party with the most to gain from a project finance transactionthe sponsorto sacrifice a mere pittance in comparison to what it stands to receive if a project is successful. In the process, the sponsor absorbs very little of the risk associated with a project. In this scenario, all of the risks of a project flow to other partiesthe lenders 294 and third partieswho lack meaningful control over a projects management and who stand to gain relatively little if a project succeeds. Reworking equity contribution amounts would alleviate this imbalance and allow the sponsor to realize a return on its investment while simultaneously, and more appropriately, bearing more of the risk associated therewith. C. Limit Use of Special Purpose Entities With respect to direct project participants, the SPE is typically seen as a tool to enhance financial outcomes; however, as previously discussed, the SPE also allows the project sponsor to avoid feeling the full impact of losses associated with a projects failure. If the transactional structure is collapsed, not only would the liabilities of a project appear on the balance sheet as part of the sponsors bottom line, but it would also create more of an opportunity for the sponsor to engage in the activities of the project throughout the projects lifetime. 295 Such engagement could have a positive ripple effect both with respect to business practices and the projects relationship to the local community. By collapsing the project structure, the true face of the project is unmasked and the sponsor is more likely to be seen as the face
294. See Estache & Strong, supra note 2, at 17 (noting that sponsors limited exposure in project finance transactions results in lender assumption of a part of project risks). 295. See ESTY, supra note 3, at 3 (noting that direct project ownership would prevent opportunistic behavior).
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responsible for any benefits or harms of the project. 296 This carries reputational weight, and it therefore follows that the sponsors might be more inclined to adopt more sustainable business practices that engage the community in the decision-making process. The sponsor is also more likely to pay for what it breaks, rather than shift all responsibility to a project company that is unsupported in any meaningful way by the sponsors deep pockets. 297 Tort claimants in Oaxaca could benefit from this arrangement. As it stands, the lenders have liens on all of the project assets. Under this proposal, and assuming a nonrecourse finance model, the lenders would maintain their security interest in the project assets, leaving the sponsors assets available to third-party tort claims. 298 Opponents to collapsing the structure of project finance transactions could argue that the economic benefits accompanying the prior form would be altogether lost, and therefore investing in risky infrastructure projects would become unfeasible, from an economic perspective. Therefore, they might conclude, everyone loses, including the third parties most affected by the positive and negative externalities of infrastructure development. 299 This economic argument fails to acknowledge the social costs that never fully figure into developers calculations relating to development, 300 and that such costs undermine the purported efficiency of the project finance model. 301 In the Oaxaca
296. See, e.g., Schwarcz, supra note 14, at 11213 (discussing the rationale for piercing the corporate veil and noting that where limited liability is absolute, a parent can form a subsidiary with minimal capitalization for the purpose of engaging in risky activities[,] which exceeds what is deemed socially acceptable). 297. See, e.g., Steven L. Schwarcz, The Inherent Irrationality of Judgment Proofing, 52 STAN. L. REV. 1, 3132 (1999) (discussing transactions between related entities and noting that [n]onarms length transactions are more likely than arms length transactions to be entered into for judgment proofing.). Off-balance sheet financing is one of the key rationales supporting the use of SPEs in project development, but the potential of the SPE to render the sponsor judgment proof looms large in any project finance transaction. 298. This framework resembles the carve out advocated by Professor Elizabeth Warren during the discussions regarding the revision of Article 9 of the Uniform Commercial Code (UCC). See, e.g., Elizabeth Warren, Making Policy With Imperfect Information: The Article 9 Full Priority Debates, 82 CORNELL L. REV. 1373, 1395 (1997) (discussing perils full priority pose to tort claimants). See also Hughes, supra note 21, at 881 (posing a hypothetical UCC amendment that would allow third-party tort claimants to obtain a security interest in a project finance debtors property during a period of time in which [such debtor] was also violating prescribed human rights, labor, or environmental standards). 299. See Schwarcz, supra note 14, at 110 (noting that [w]hen economically beneficial transactions are prevented, all parties suffer.). 300. Cf. ESTY, supra note 3, at 21112 (describing a framework for evaluating the impact of development). 301. See Schwarcz, supra note 14, at 121 (assuming that externalities should be allowed to defeat contract enforcement only where [a] minimum threshold is met and the externalities cause the contracting in question to become economically inefficient.). Professor Schwarcz goes on to explain that two types of efficiency are generally referenced in the law and economics literature: Pareto efficiency, where the contracting puts contracting parties in a better position and does not make any parties worse off; and Kaldor-Hicks efficiency, where the aggregate benefit exceeds the aggregate harm, including externalities. Id. at 12223. The Oaxaca projects would likely fail under each model, as the aggregate harm, among them the potential
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privately developed wind project examples, all of the energy produced is being transported to large corporations. In exchange for this beneficial development, the land is disrupted, the water table is affected, and large, towering windmills are permanently placed on communal land. Therefore, it could be argued, the community never stood to gain in the first place. Changing the corporate structure of project finance transactions could bring costs and benefits more into balance. Removing the cover of the SPE simply brings liability a bit closer to home and forces the developer to consider fully the social costs of its activities. Although, under the modified form, the complex web of agreements that is standard to project finance transactions would not go away, the causes of externalities would be more readily traceable to the sponsor, rather than an amorphous entity that is merely the sum of its contracts (e.g., the project company). 302 When the SPE disappears as a vehicle that carries all of a projects risks, the who of the project is brought into sharper relief. Without the SPE, the project sponsor absorbs more of the risk of the negative externalities that will be produced by the project, and the likelihood that affected parties may effectively seek redress for harms caused by a project also increases. D. Additional Research Others have theorized the potential impact of making changes outside the financing form in order to effect real change for those affected by large-scale projects financed by project finance, 303 but this article argues for deconstructing the form and examining the merits of the respective elements thereof. The three suggestions enumerated herein barely begin to address the risk-shifting properties of project finance, but they are a step in the right direction. Extensive empirical research is needed to understand the impact of project finance, as a specific infrastructure development financing form, in various environments, and how the permutations of the form manifest different results. 304 We cannot rely on the argument that the social benefits of development outweigh the harms
displacement of indigenous communities and potential environmental harm, arguably exceeds the corporate and green benefits of the projects. 302. See ESTY, supra note 3, at 2 (noting that project companies are founded on a series of legal contracts.). 303. See, e.g., LIKOSKY, supra note 114 at 170 (arguing for the creation of a human rights unit under the United Nations to handle human rights issues arising in the context of [transnational public-private partnerships]). 304. More inquiries into project finance methodologies and externalities may reveal, ultimately, that the mechanism is so flawed that it should be altogether eliminated. I decline to make that claim here, but suspect that structural and market fixes may fail to redistribute the costs and benefits of this form of infrastructure finance and that a more profound intervention may be required. This article aims to begin the discussion and begin to expose the links among the structural deficits of project finance, risk diffusion, and the social and environmental externalities that result.
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caused by the form. 305 For indigenous communities impacted by development, this claim is specious at best. We must do more. In particular, we must seek to answer the question of whether there are particular structural mechanisms that can close the gap and prevent the interstitial matterthe risk of social and environmental externalities from regularly seeping through the tightly negotiated form and onto third parties. VIII. CONCLUSION The discourse surrounding infrastructure development finance suggests that the only way to engage project sponsors in risky infrastructure development projects in the Global South is by deploying financing mechanisms that adequately allocate risk. This discourse further suggests that the use of contractual mechanisms is efficient: They will effectively distribute risks throughout an efficient framework that allocates rewards to the parties that are best positioned to control and absorb such risks. Moreover, the expert players who routinely engage in development behave rationally in order to maximize returns. The current outcomes related to the pervasive use of project finance challenge these principles, and indicate that the widespread use of project finance in the Global South creates significant cause for concern. Some argue that project developers, as parties responsible for creating a large-scale infrastructure projects, have so much at stake throughout the lifetime of the project that they need effective ways to distribute risk to parties best able to absorb it. As this article demonstrates, however, such developers actually have very little at stake in a project finance transaction and in fact shift many key project risks on to parties least able to absorb them. Indeed, project finance is so adept at risk diffusion that environmental and social risks more appropriately borne by project sponsors and project decision makers ultimately, and consistently, fall on the shoulders of third parties. Thus, project finance, and its risk allocation framework, wreak havoc in the development context by creating perverse incentives for development. This article begins to expose many of the structural deficits native to the most commonly used mechanism for infrastructure development finance and disrupts the assumed neutrality that accompanies its form. These structural deficits create a development environment where risk is shifted away from project developers and externalities are borne disproportionately by third parties who are not parties to the project finance transaction. Assuming neutrality with respect to the form
305. See, e.g., Macey, supra note 284, at 449 (arguing that the social benefits generated by limited liability outweigh the social costs).
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obfuscates the harm that often arises from large-scale infrastructure projects, and severs the causal link between the form and the risks ultimately dispersed onto third parties. The body of scholarship that examines these relationships is woefully sparse in the infrastructure finance, development, environmental, and human rights disciplines. Academics across these disciplines should therefore work together to understand the structural deficits inherent in infrastructure development finance and strive to rewrite, perhaps radically, this deeply flawed paradigm.

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TEXAS JOURNAL OF OIL, GAS, AND ENERGY LAW

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UNMASKING PROJECT FINANCE II. INTRODUCTION

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TEXAS JOURNAL OF OIL, GAS, AND ENERGY LAW C. Structural Components

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