Long term contracts with output purchasers are the source of cash flow by which the lenders may be paid. Take-or-pay contracts, throughput agreements and tolling agreements are in substance guarantees of cash flow for the project.
In a take-or-pay contract, the output purchaser commits himself to make periodic payments of specified amounts whether or not the product contracted for is delivered. His obligation to pay is thus independent of the actual delivery of the product. It is also independent of the quality of the product delivered. The borrower and the lenders are thus assured of funds for servicing the project's debt obligations.
The throughput agreement is similar to the take-or-pay contract except that the counter-party is the user of a facility. The most common subject matter for a throughput agreement is a pipeline. The user promises to pass a specified minimum amount of petroleum or gas through the pipeline; he undertakes to make the payment associated with the minimum use whether or not he actually passes the minimum amount through the pipeline. The amount specified is usually pegged to the cash flow necessary to cover the operating cost and the debt service obligations.
The tolling agreement is a variation of the throughput agreement. The term is applied to an agreement between a processing facility and its customers who send their raw materials to the facility for processing. In a tolling agreement, the customer promises to send a minimum quantity of material at an agreed rate. The guaranteed payment may take the form of a capacity reservation fee.
The strictness to which a purchaser is held to his payment obligation is largely a function of how the obligation is drafted. As a buyer's obligation to pay is normally construed to be dependent in some way on the seller performing his part of the bargain, the independence of the two obligations must be manifest. While the more developed legal systems give due recognition to contracting parties' conscious assumption of onerous obligations on the ‘pactasuntservandaprinciple’, adjudicators in less sophisticated legal systems may subordinate the ‘pactasuntservandaprinciple’ to the perceived need to address the seeming unfairness of the obligation assumed. Parties dealing in less developed legal systems should therefore investigate whether the covenants they normally use have the same effect.
Tightly drafted long-term contracts, which virtually guarantee the cash flow to a project, are valuable as collateral. Indeed, lenders often insist on such virtual guarantees so that the proceeds may be assigned to them as security for repayment. There are a couple of ways by which the benefit of such contracts may be appropriated to the exclusive benefit of lenders. The right to receive payment may be charged or assigned to the lender. If there are several lenders, the receivables may be assigned to a trustee who open an account into which the output purchasers are obliged to make payment. The moneys in the account are thus held on trust for the exclusive benefit of the lenders. Such arrangements enable lenders not only to be protected against the uncertainty of future cash flows; they also insulate lenders from the difficulties that attend the project's insolvency.
In an infrastructural project where the government is the purchaser of the output such as power generation projects, the government may enter into a long-term contract for the supply of the output at a pre-determined price. This effectively guarantees the cash flows to the project. The risk of price fluctuation and hence the element of market risk is removed. Whether the government purchaser is willing to assume a payment obligation in- dependent of the product delivery will depend on how keen the government is to see the completion of the project. While such commitments insulate the project from the perils of the market, the market risk is replaced by the political and sovereign risk.
As a conclusion in order to mitigate the risk, firstly parties have to identify and categorize the risk and take their contractual measures accordingly.