FINANCING ESCO ENERGY EFFICIENCY PROJECTS | Page 2

ESCO PROJECTS

FIGURE 1 - A TYPICAL FINANCING STRUCTURE

Parent shareholder

Direct agreement / contract

Payment / Performance bond / LOC Equipment supply subcontract

Surety / LOC Issuer

Equipment supplier

Indemnification / reimbursement agreement

ESCO and the ESPC needs to provide for a full assumption by the ESPC of all of the ESCO ’ s performance obligations under the ESA ( ie , a full pass through or “ flow down ” from owner to ESCO , and from ESCO down to ESPC ).

The security package will typically include a collateral assignment by the ESCO to the lenders – or their collateral agent – of all the ESCO ’ s assets and contractual rights . This would include in particular the granting of a security interest on the actual EEF to the extent the EEF is to be owned by the ESCO after the commencement of commercial operation of the EEF . If the owner only has leasehold title to the underlying property , there may be a need to obtain the property owner / landlord ’ s acknowledgment and agreement as to the ESCO ’ s lenders ’ rights to exercise their remedies over the EEF collateral in case of an ESCO default under the financing documents .

In addition , the lenders will require consents to assignment , or direct agreements , from the owner and the ESPC , respectively , whereby each acknowledges and consents to the assignment by the ESCO of its contracts with them to the lenders or the collateral agent and recognises the lenders ’ or the agent ’ s right to cure and “ step in ” and take over the ESCO ’ s obligations to install and / or maintain the EEF in case of an ESCO default , and to the exercise of other remedies .

As in most project financings , the lenders will require as additional security a pledge of all of the ESCO ’ s bank accounts relating to the project , including generally ( a ) a construction account where loan proceeds will be escrowed and disbursed during construction subject to the approval of an independent engineer acting for the lenders ; ( b ) a revenue account , where payments from the owner will be deposited and funds will be disbursed in accordance with a customary waterfall ; ( c ) debt service and possible other reserve accounts ; and ( d ) an insurance proceeds account . Finally , the ESCO ’ s shareholders will be required to pledge their equity interests in the special-purpose ESCO .

For its part , the ESPC ’ s performance ( and payment ) obligations under the construction and maintenance agreements should be secured by a third-party letter of credit or performance bond from a creditworthy issuer or surety satisfactory to the lenders .

One of the challenges of these financings is that in some cases , the market value of the EEF may not be sufficient to cover the borrower ’ s debt obligations in case of a default under the financing documents . Thus , the credit quality of the owner will be a key element of the transaction , which may be enhanced if necessary by some form of sponsor credit support .

Another challenge to project financing an energy efficiency project is project size . While the limited or non-recourse nature of a project financing is most often appealing , execution costs for a project financing can be considerable , resulting in either limited lender appetite , or limited cost effectiveness for the transaction parties . This can sometimes be solved where a number of energy efficiency projects that are small individually can be bundled together to benefit from a portfolio financing .

Finally , the ESCO may be able to access certain tax incentives in connection with project financing an energy efficiency project . For example , if the ESCO or an affiliate constructs a qualifying solar project , and either sells electricity to the owner pursuant to a power purchase agreement or leases the project to the owner , the ESCO ( or affiliate ) may be eligible to claim a federal investment tax

Project Finance International October 6 2021 67