The direct agreements solution

By Katie Liszka
Direct agreements are used in project finance transactions to provide lenders with protection should the project get into difficulty. These are contractual mechanisms that enable the lenders to step into the shoes of the project company (the borrower) and take over the project and/or find a substitute entity to continue the project. The parties to the direct agreement include the project company itself and the counterparty to the project document to which the direct agreement is collateral to.

Direct agreements usually contain provisions covering the following issues:

• Consent to security;

• Agreement of the counterparty to give lenders a termination notice and not terminate the project document for a specified period;

• Ability of the lenders to give notice during the specified period or following an event of default under the facility agreement that they will appoint an entity to assume the project company’s rights and obligations under the project document;

• Ability of the lenders during the step-in period to permanently transfer the rights and obligations of the project company to a substitute entity; and

• Amendments to the project document required by the lenders.


Consent to security

To the extent required, a direct agreement may include clauses where the counterparty to the project document consents to the charging or assignment by way of security of the project company’s rights under the project document.



When the counterparty agrees not to terminate the project document for a specified period of time, the lenders have to decide whether or not to step in during this period.

The period is triggered by the counterparty serving a termination notice, which will give details of the grounds for termination. The lenders will also require details of the outstanding obligations, including payment, at the time of the notice and those due to be performed before the end of the specified period. This will allow lenders to assess the extent of the obligations and liabilities they will assume should they decide to step in.

Lenders will want the specified period to run from when the third party can terminate and not to run concurrently with the contractual notice period.

In addition to the counterparty agreeing not to terminate should it have the right to do so under the project document, it will also agree that the step-in process can be triggered by the lenders serving notice of a project company default under the facility agreement, there being enforcement of security or acceleration of the loan.


Step in

To step in, notice has to be given during the specified period that the lenders have appointed a representative to step in and administer the project document. The third party is then to deal with the appointed representative exclusively and not the project company. This situation is achieved legally by the project company and the appointed representative being co-obligors and jointly and severally liable for the project company’s obligations. It is usually done in this way as step in is only a temporary state of affairs and the aim is not to transfer the rights and obligations of the project company permanently by way of assignment or novation. This mechanism allows the appointed representative to easily step out.

An issue that may be intensely negotiated is what the lenders are liable for on stepping in. They will take on responsibility for outstanding payments and unperformed obligations that they are notified of. What is often contested is the extent to which they take responsibility for unknown and un-notified liabilities. Lenders will only wish to be responsible for liabilities that they are made aware of. The third party consenting to step in will obviously want lenders to be responsible for everything.

A further issue that can be intensely debated is the length of the step-in period. From the lenders perspective, this is ideally not limited. The argument in favour of this position is that the third party should not be concerned with the length of the step-in period as, at this stage in the process, the appointed representative is performing the obligations of the project company. It should be remembered that this is the period in which lenders have to rescue the project and/or find a permanent substitute to the project company.


Step out

The appointed representative can step out on notice. This will take place when either: a permanent substitute is found, the project is returned to the project company, or the lenders decide that the project cannot be rescued. Again, there can be a debate over the extent of the appointed representative’s liability in respect of unperformed obligations.

If a suitable substitute is found, the obligations of the project company will be permanently transferred to the substitute. The third party will be concerned with who a suitable substitute can be, not wanting the substitute to be a competitor for instance. The lenders will obviously be concerned that there is not too much of a restriction on possible substitutes, particularly if there are only a small number of possible replacements that have the required expertise.



A direct agreement often includes amendments to the underlying project documents. This is particularly the case for concession agreements where the project company is awarded the concession before the lenders have become heavily involved. The financing often follows award of the concession and the lenders may require amendments to the risk allocation in the concession agreement to make the project bankable.

There is not usually a debate about whether in principle a direct agreement should be given. It is however still common for certain provisions to be intensely negotiated and often it seems as though a disproportionate amount of time is spent concentrating on such a short agreement. To my knowledge, no one has ever stepped in under a direct agreement and there would be practical difficulties in doing so, such as novating all project contracts. However, direct agreements are common practice and a standard part of a lender’s security package.

Gulf Construction

  1. Dear Sir,

    Wouldn’t termination of EPC Contractor services prolong the project
    completion period, since a new EPC contractor shall be replaced
    the previous one?

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