Most project finance loans are secured loans where the project secures the loan in the event of a default, and creditors cannot make additional claims. Some are limited non-recourse loans, guaranteeing a set amount to creditors if a default occurs, but not allowing additional claims against the loan. Some can be backed by additional guarantees to access more funding through lenders who might be reluctant to extend large loans without assurance of payment if a problem arises over the course of a project. Financing projects like bridges, roads, and major structures can be challenging because of the large amounts of money involved and the complexity of these projects.
In a non-recourse project loan, the borrower agrees to use the project itself, including the cashflows it generates, as collateral on the loan. If the borrower defaults during construction or after repayment, the lender can seize the project and attempt to recover the loss. This can work for projects like apartment buildings and office high rises, where the lender can use the project in some way to compensate for the losses. On projects like bridges, this type of loan is not as suitable.
Another option is the limited non-recourse loan. In a limited loan agreement, the creditor is guaranteed a set percentage of the loan. This guarantee can come from a government agency or the government itself with some projects, and can also originate with investors who provide the backing in exchange for a share of proceeds. Limited project finance loans tend to be less risky because of a guaranteed outcome, but because it only represents a percentage of the total, the loss for the lender can be significant.
With both types of project finance loans, clauses in the contract prohibit the lender from getting additional funds out of the project in a default. Once it becomes clear that the loan cannot be repaid, the lender must take the settlement offered in the terms, and has no additional recourse to recover more funds. Lenders must consider this risk when they issue project finance loans, and may charge high interest or create other terms to structure the loan carefully and minimize the potential for problems.
It is common for project developers to create a special purpose entity (SPE) to handle financing, like project finance loans, for the project. The entity is separate from all other business operations, which isolates the project from other endeavors. This ensures that if a project fails, it will not take an entire company down with it, and assets that belong to the company will be shielded from creditors associated with the project. The creditors can only work with the SPE, and do not have access to funds from associated companies and organizations.