Lessons Learned from Tuxpan V and Choloma III

The Tuxpan V and Choloma III power projects gained international recognition in 2004 for their innovative financing structures and the speed with which they were financed. Here, the lead attorney for both projects shares his strategies for successfully financing Latin American energy projects.

Last year two projects shattered the development and financing records in their respective regions. The record setting projects were the Tuxpan V power project in Mexico and the Choloma III power project in Honduras. The financing structures utilized in both these projects and the speed and efficiency with which they were financed have become the standard by which other infrastructure projects in Latin America will be judged. The speed and success of Tuxpan V and Choloma III were achieved through a number of strategies that I will outline in this article. In order to assure that the development of a project has the best chance of success, I would suggest the following steps be taken:

1. Select the Right Team
2. Develop a Detailed Strategy
3. Develop a Comprehensive Term Sheet
4. Agree on an aggressive schedule
5. Maintain the schedule rigorously
6. Begin the documentation process as soon as possible
7. Maintain a small, focused team
 
Step 1: Select the Right Team

As with any venture, the make-up of the development and financing teams for each of the projects was critical to their ultimate success. It is crucial that the team members for any Latin American project development have extensive experience in the region. Their familiarity with the legal and regulatory frameworks of each Latin American country will permit team members to appreciate and navigate the barriers and potential pitfalls which will inevitably plague any development or financing in Latin America.

As the lead attorney for the project teams on both the Tuxpan V project and the Choloma III project, it was crucial for me to maintain an aggressive schedule based on pre-agreed deadlines established by the sponsors and lenders. Additionally, it was also important to establish an efficient channel of communications with the lenders and their consultants, particularly their counsel. Maintaining constant communication among all team members ensured that any issues arising during the course of the financing were quickly addressed.
In addition to assembling the correct project sponsor team and choosing a knowledgeable and motivated project lender, the selection of the right consultants (particularly, legal counsel) will greatly influence a project’s ultimate success or failure.
 
Bilingual Team Members

Having team members with ability to speak Spanish or Portuguese, as applicable, on a Latin American project team is extremely important in ensuring speedy and effective negotiations and the proper documentation of any Latin American project. Requiring all team members to have language abilities increases the effectiveness of a Latin American project team. Many times project sponsors and lenders hire legal consultants where the senior lead team member leading the discussions cannot even read the underlying documentation on which the economics and integrity of the project are based. In these cases, a fatal flaw analysis of the project is based on the evaluation of the project documentation by a junior associate or a foreign LLM associate on loan to the law firm. With millions (and sometimes billions) of dollars at stake, one would hope that the senior team member evaluating the project would be able to read the underlying project documentation for himself or herself. Additionally, although many times the negotiations relating to project documentation or financing are conducted in English, it is important for team members to be able to negotiate in Spanish or Portuguese, as appropriate, in order to participate in negotiations conducted in the host country. On numerous occasions, I have been in meetings where a negotiation conducted in English has stalled and it was critical to discuss the issue in Spanish with a smaller group in order to properly understand the underlying issue troubling the counterparty. Once the issue was properly identified and a proposed solution could be assessed, the negotiations were again commenced in English with the participation of the larger group.

The Pitch Team Must Be the Deal Team

In evaluating the credentials of a consultant team it is important to not base a decision to retain a team based on glossy presentation materials and a long list of deals which the firm credits itself for closing. In many cases, the deals listed by a firm may be outdated (given the rapid pace of change within a particular market) or have been closed by personnel which are no longer with the firm. Project sponsors or lenders looking to engage counsel or other consultants should insist that all proposals submitted be accompanied by deal lists setting forth only the relevant deals on which the proposed team has personally worked on. Additionally, it is important to condition the retention of a firm on the requirement that the proposed “pitch” team be the actual “deal” team which staffs the project.

Market Knowledge

A successful project team must be comprised of team members with relevant market knowledge. Broad knowledge of the Latin American energy market is helpful because many times a potential solution to a problem can be found utilizing lessons learned in other markets. For example, one may be able to address a fuel supply issue with a solution first derived from a project with Pemex in Mexico, Petrobras in Brazil or Ecopetrol in Colombia. Issues are often very similar among markets, so it is important to be aware of comparable markets in various countries in order to taken advantage of creative solutions regardless of their origin.

Past Results

Always base the decision to hire a team based on the proposed team’s past results rather than on a brand name. Firms, like all other companies, change personnel and it is important to recognize that one is hiring an individual for his or her own talent as opposed to a deal list or brand name. The best brand name will not benefit a closing if the individual leading the team does not have the requisite skills to “get the job done”.

Step 2: Develop a Detailed Strategy

The success of both the Tuxpan V and Choloma III financings was based on the development of a detailed strategy to achieve the goals of the project sponsors and lenders. It is important that a detailed time schedule be determined for each task. Engaging experienced project counsel early in the process will increase the chances that a project will be successfully developed and financed. Experienced project counsel can develop a roadmap based on recent successes that will greatly expedite the completion of project agreements and the finalization of financing documentation. The more items (including the permitting schedule and timeline for receiving specific drafts of project and financing documentation) that are detailed in the strategic plan, the greater will be the chance of achieving the schedule for each task.

Step 3: Develop a Comprehensive Term Sheet

During the financing of the Tuxpan V project, the project sponsors developed an extensive financing term sheet which the prospective lenders were required to approve. In some cases certain items were left for further discussion during the documentation stage of the financing. Having an exhaustive term sheet ensured that all parties were in agreement with the basic terms of the financing. The Tuxpan V term sheet (which exceeded 70 pages in length) greatly accelerated the financing cycle of the project. Because the parties had discussed and agreed upon the majority of the financing parameters (including the inclusion of materiality clauses), there were very few surprises in the initial drafts of the financing documentation. A fatal flaw in many term sheets is a clause stating that the documentation will contain customary provisions. It is amazing to see how many different understandings there are among market participants as to what the“market” is. Usually the “market” is determined by the last project closed by the person defending his or her position. Although one cannot itemize all the terms to be contained in the financing documentation, the development of a comprehensive term sheet does provide an opportunity to identify key issues to be solved among the parties.

Step 4: Agree on an Aggressive Schedule

In order for this process to be effective, it is important for the key decision makers and their consultants to agree to an aggressive schedule for the completion of project agreements and financing documentation. Letting the process take its “normal course” will doom any project to entanglement in protracted negotiations, which lead to deal fatigue and result in frustration among the parties. Having predetermined deadlines forces team members to resolve issues or at least limit outstanding issues to a small basket of deal points to be closed out by top management.

Step 5: Maintain the Schedule Rigorously

The more aggressive the time schedule the project sponsors are able to get other team members to agree upon, the lower the overall project costs will be (thus resulting in a more profitable project for the sponsors). Providing for shorter deadlines limits the discussions of the parties to the important issues rather than negotiating every proviso in each contract clause. The project sponsors must take the lead in demanding that all team members adhere to pre-agreed deadlines.

All parties should agree on an updated schedule at each meeting and assign responsibilities for each task in writing. Ownership of a particular task increases the likelihood that it will be completed.

Step 6: Begin the Documentation Process as Soon as Possible

Although developing a comprehensive term sheet is important, it is critical that the parties begin to discuss all financing issues based on the initial financing documentation as soon as possible during the financing cycle. Discussing issues based on the actual financing documentation permits the parties to fully appreciate the parameters of each issue. This process avoids having the parties initially believe that they have an agreement on an abbreviated term sheet summary and later realize that each party had a different understanding of the issue once the full contract language is presented. Additionally, negotiating financing issues based on actual language avoids negotiating the same issue twice.

Take Reasonable Positions

Rather than engaging in “positional” based negotiations where each party begins to negotiate at extreme positions and movement from their position requires a concession from the other party, it is important that each party begin negotiating from a rational and fair position.  The egos of the parties and their negotiators need to take a “back seat” to finding an equitable solution to outstanding project issues. In the case of the Tuxpan V and Choloma III projects, both projects benefited from the common understandings between the project sponsors’ counsel and the lenders’ counsel, which was gained over the course of several projects that the parties had previously worked on together. It is important to always look for synergies based on previous successes.

Know Current Market Standards

As mentioned earlier, the market knowledge of the team members will permit the process to move pass many issues based on current market standards being dictated by the international lending community. Having a clear understanding of current market standards helps eliminate the danger of a party taking extreme positions which are likely to derail project or financing negotiations.

Provide Detailed Comments

In order to maintain momentum during project and financing negotiations, it is important to provide detailed comments to all documentation. Providing detailed comments with actual proposed language assists both parties to more clearly define what would be acceptable to each party. Rather than discussing conceptual solutions each party should focus on the actual language to be included in the documentation. If the language proposed by one party is not acceptable to its counterparty, then the counterparty can utilize the proposed language as a starting point for its counterproposal. Similar to the term sheet discussions, negotiating terms on a conceptual basis can lead to frustrations when contract language is proposed at a later stage.

Always prepare an “issues list” with proposed contract language for each point. Require that each meeting result in progress on the issues list (e.g. a shorter issues list). If the lawyers cannot agree on a workable solution, then hold a businessperson-only meeting to discuss the issues. Once tentative positions are agreed upon reconvene a meeting with the larger group. The goal of each transaction should be to “get the deal done” rather than win ego points for each consultant.

Quick Turnaround Time is Essential

Maintaining the right pace during project negotiations is essential to ultimately achieving shortened development and financing cycles. During the financings of Tuxpan V and Choloma III, our project team required turnaroundtimes of approximately 3 days. As soon as revised financing drafts would arrive, the sponsor team would commit to providing the lenders with revised drafts incorporating proposed language within a designated period. The project and lender teams would then hold face-to-face meetings within a 2-3 day period after the lenders received the sponsor drafts. On the last day of each meeting, the project sponsors would require the lenders to commit to returning the financing documentation within a specified period. Although the pace was intense, it ultimately shortened the financing cycle for each project to ¼ of the normal financing cycle in each region. Additionally, requiring a rapid turnaround time for documentation forces the parties to focus on the most important issues and minimizes a party’s ability to raise “new and creative” issues during downtime. Shortened response times also reduce project costs for the sponsors because the time all the consultants involved in the process can charge on a project is limited. This process also forces the review of the documentation to be limited to the key decision makers for both sides thus limiting the “full employment act” syndrome where everyone on a massive email distribution list decides to review the document (and charge for their review) without adding any tangible benefit to the process.

Step 7: Maintain a Small, Focused Team

Limits Costs

Maintaining a small deal team ensures that each team member is forced to be familiar with all aspects of a project. Having a focused deal team will increase the likelihood that the transaction will be closed more rapidly because having too many members on a team results in chaos and efficiencies. It is important that each team member be assigned specific responsibilities for each aspect of the deal.

Increases Efficiency

In addition to lowering project costs, a small deal team will be able to react more quickly to issues which arise and thus be more effective in closing the transaction. It is critical that team members be dedicated to the project throughout the process rather than permitting team members to “come and go” based on commitments on other deals.  Project sponsors must insist that they not be charged for any inefficiencies caused by the replacement of team members throughout the development and financing of a project.

Conclusion

The parameters and process discussed above have proven successful in two separate projects and in two challenging regions and thus cannot be assumed to be a “one-time fluke” or a “flash-in-the-pan” success story. The structure and process set forth in the above outline can be applied to the development and financing of any project regardless of type and location.

The success of the Tuxpan V and the Choloma III projects has shattered the assumption that projects being developed in the Latin American market are intrinsically difficult to structure and finance. After the success of these financings, the new market standard is a “quick, well-structured and cost effective financing” for all projects. Project sponsors, having real world examples to point to, will insist on similar results for their projects and will push their project teams and prospective lenders to shorten development and financing cycles.

This article was written by Dino Barajas, Partner with the Corporate department (specializing in project finance and Latin American transactions) of Paul, Hastings, Janofsky & Walker LLP (www.paulhastings.com). You may contact the author by telephone at (213) 683-6130 or by email at dinobarajas@paulhastings.com. The author welcomes questions and comments regarding the article. Mr. Barajas has been recognized with a “Lawyer of the Year Award (Energy)” for 2004 by California Lawyer Magazine. Additionally, Mr. Barajas has been recognized as one of only four California lawyers in The International Who’s Who of Project Finance Lawyers 2005.