Global investment into large-scale projects in infrastructure, energy, natural resources and heavy industry continues against an uncertain backdrop of the COVID-19 pandemic, heightened trade tensions and regional geopolitical instability. The forces driving these investments, such as the world’s ongoing demand for sustainable energy and new and renewed critical infrastructure, for example, are long term in nature and will outlive both this pandemic and a next one. The formation and mobilisation of global capital into instruments and vehicles focused on these important sectors is generally accelerating. With such acceleration, enhanced focus on the optimisation of project development transaction structures is becoming paramount for the success of these projects and the returns to their sponsors.
In the project development context, a joint venture transaction will often feature several different participants. A lead investor or originating sponsor may source or initiate the project and recruit co-investors who bring valuable resources to the table, such as industry or geographic expertise, valuable intellectual property (IP), resource-abundant real estate or simply substantial equity cheques. As the project matures from its infancy at the idea stage into bankability, lenders and debt financing sources may also become involved. Utility and other regulated infrastructure projects may come to involve a partnership with a government or municipality which may seek to own an interest in the project. Where the project involves the production of commoditised offtake, prospective off-takers may also prefer to participate at a minority investor level. To align participants’ interests, sponsors may ultimately issue minority stakes of equity that will provide each participant with a sense of ownership and shared responsibility for the project’s success. This article will survey several meaningful governance protections for investors evaluating minority participation in project development joint venture transactions.
Board representation and participation
A minority investor needs access to information to monitor its investment and evaluate the decisions it faces over a project’s lifecycle. The most critical information is explored and collated among the project investment entity’s board of directors (or analogous committee). When entering into a project joint venture, minority investors should advocate for representation at the board – either by way of a directly nominated and irrevocable voting seat on the board, or by way of dedicating a representative to serve as a non-voting observer of the board – with full rights to attend meetings and receive board materials, updates from management and related correspondence. Ideally, reference to a minority investor’s board representative would be incorporated into quorum requirements in the project entity’s organisational documents, such that corporate actions of the project entity may not be undertaken without such representative’s participation in the relevant organisational proceedings.
Project information rights
To the extent board participation alone does not secure access to sufficient information required to properly monitor the project development and execution process, minority investors should consider additional information rights above and beyond those available at the board level or any extant books and records inspection rights available under applicable law. Since all investors benefit from additional information, consensus often emerges in favour of these rights, but information rights should also be counterbalanced against the cost and effort required to produce them. For example, key personnel should be focused primarily on the growth of the project as opposed to periodic report generation. Without a consistent pipeline of accurate and timely project information, many of the other minority investor protections surveyed below are significantly attenuated, if not practically inactionable, to a minority investor.
Project secondee appointment rights
Minority investors can both contribute to the project development effort and monitor the development process firsthand by the appointment of a skilled representative of the minority investor to the project on a fee-for-service, full-time, part-time or rotational secondment basis. Secondees can act as an invaluable link between the project and their home organisation. Project development teams usually appreciate an additional pair of hands to assist on-site in functional areas where the secondee can add value and integrate with the team. It is important to clearly delineate secondee duties and scopes of responsibilities to avoid duplication of effort, conflicts of interest or confusion surrounding the decision-making authority. Further, care should be taken to allocate risks and liabilities appropriately, so that a minority investor does not become unduly exposed to liabilities arising from project work undertaken by their secondees acting at the direction of a project sponsor.
When a minority investor decides to participate in a project, it is making a commitment to dedicate its time, effort and resources to the project’s commercialisation and success at the expense of other investment opportunities. From a minority investor’s perspective, lead sponsors should similarly commit to exclusively channelling their efforts in an industry solely through the project and not through additional, competitive ventures. It would be disastrous for a minority investor to bring a unique suite of assets to a project, hoping that the lead sponsor is equally dedicated and exclusively committed to the project, only to realise that the lead sponsor is improperly leveraging minority investor contributions to develop competing ventures or platforms that significantly undermine the minority investor’s interest. In this context, minority investors benefit from non-competition, customer or vendor non-solicitation, employee no-hire, or other stakeholder no-contact covenants that prevent a lead sponsor from abusing the contributions and resources of their co-investors – typically in force and effect throughout the duration of the project, plus a negotiated period thereafter. A well-drafted covenant defines the ‘business’ of the project and requires other investors to refrain from a proscribed universe of ‘competitive activities’ that would cause harm to the project. These provisions are subject to jurisdiction-specific competition laws and can be heavily negotiated and quite contentious, but when properly drafted, they provide meaningful protection to both minority investors and the project itself.
Reserved matters, vetoes and voting thresholds
Much of the difficulty in joint venture negotiations revolves around the consent requirements and thresholds required for a project entity to validly undertake critical decisions and actions. While jurisdiction-specific laws may inherently confer some levels of consent required for an entity to validly act (usually majority vote), it is common for project joint venture documentation to specify that certain fundamental decisions (‘reserved matters’) may not be undertaken without the specific approval of certain investors. This allows minority joint venture partners to ‘veto’ any reserved matters they deem detrimental to their interest and protects against controller abuse. For practical and confidentiality reasons, this protection is customarily included in a separately-delivered shareholders’ or investor rights agreement, as opposed to included in the governing documents of a project entity, which may need to be refiled in a jurisdiction when amended, required to be disclosed to third parties, or are otherwise publicly retrievable from time to time.
Depending on the laws of the jurisdiction of incorporation or formation of the relevant project vehicle, reserved matters should be decided among the equity holders of the project entity – not the board of directors or managers of such entity, who may be subject to fiduciary duties that obligate them to act in the best interest of the entity taken as a whole, instead of the best interests of their respective nominating investors individually.
While these provisions are highly bespoke and often the product of protracted discussions and fact-specific circumstances, below are several of the most common activities included within the universe of reserved matters: (i) changes to the project entity’s governing and organisational documents; (ii) issuance of additional project ownership interests; (iii) issuance of dividends or changes in distribution policy; (iv) incurrence of indebtedness; (v) capital expenditures; (vi) sale, lease or encumbrance of key project assets or property; (vii) entry into (or termination of) material project contracts; (viii) licensing of project intellectual property; (ix) relocation of project facilities, sites or executive offices; (x) hiring or firing of management employees; (xi) modification of project business plan or capital budget; (xii) transactions with affiliates of other project investors; (xiii) tax elections, accounting policies and related decisions; (xiv) modifications to project consents, grants, licences or permits; (xv) mergers, acquisitions, divestitures, dispositions of assets or similar transactions; (xvi) filing for bankruptcy or insolvency-related activities; and (xvii) judicial dissolution and winding up.
Anti-dilution and pre-emption
A minority investor that contributes to a project at an early stage, possibly before economic viability becomes evident, should ensure that its equity ownership is not improperly diluted by opportunistic latecomers. To this end, minority investors would be protected by restrictions on the project entity from issuing additional equity interests in a manner that would reduce the minority investor’s pro rata ownership and entitlement to profit sharing. The two most common features sought in this context are contractual anti-dilution restrictions, such as the inclusion of equity issuance in a reserved matters category of activities, and price-based anti-dilution protection, where the project entity may not issue equity interests at a purchase price less than that paid by the initial minority investor.
After project joint venture formation, project sponsors should stay focused on developing the project. Premature departures by a lead sponsor or operator could disproportionately impact minority investors who may have entered project discussions in reliance on the long-term involvement of an experienced, marquee lead sponsor. Minority investors often request a ‘lock-up’ period of three to five years, whereby controlling investors, operating partners and key management are prohibited from selling their interests and exiting the project in an untimely fashion, which could otherwise leave minority investors inappropriately tasked with project development duties where they may lack industrial capacity or operational expertise necessary to launch the project.
Minority investors benefit from protection regarding transfers of project ownership interests of their co-investors. The most common type of this protection is a right of first refusal (ROFR), which requires a project investor proposing to transfer its interest to an unaffiliated third party to first offer the subject interests to existing project investors. This gives a minority investor a chance to increase its interest if desired, which can be useful if minority investors would prefer not to be in business with the proposed third-party transferee.
An alternative to the ROFR is a right of first offer (ROFO), which requires that, prior to an investor soliciting external third-party offers for the transfer of its interests, such investor must first allow its existing co-investors an opportunity to submit an offer for the interests proposed to be transferred. The selling investor is then free to accept or refuse such first offer. If an investor refuses the terms and conditions offered by its co-investors pursuant to a ROFO, the investor would then be free to transfer the subject interests to a third party at a higher price. A ROFO is protective of existing investors who are not proposing to transfer their interests, since it enables them to use existing project information to determine an appropriate maximum valuation at which they would relinquish their interests, taking comfort that no subsequent third-party transferee would receive a better deal (i.e., a lower purchase price for the interests) than initially offered by such investors.
ROFR and ROFO exercise negotiations can result in ‘bidding wars’ between a project’s existing co-investors and third parties for the interests to be sold; in these situations, minority investors would benefit from ‘last look’ matching rights that alert them to increased third-party bids for the subject interests and offer the minority investor an opportunity for the third-party bid to be matched or topped.
Relatedly, a minority investor should be aware that its non-controlling stake may be significantly less marketable when it becomes decoupled from a majority investor’s controlling interest. Project operators or lead sponsors with a majority or supermajority control rights may maintain enough negotiating leverage to prevent a minority investor from vetoing a disposal of their majority interest. In that situation, a minority investor who does not otherwise vie for a co-sale right in any such transaction could find itself newly joined with an unfavourable successor to the initial partner with whom they intended to develop the project. To protect against this, minority investors often contend for ‘tag‑along’ rights whereby they too can dispose of their interest on the same terms and conditions as an exiting majority investor and avoid becoming stranded in a venture where they may no longer be aligned with the lead sponsor.
Emergency exit: the nominal put
In dire situations, minority investors may want to exit a project joint venture with haste. Be it market volatility in the estimated price or value of project offtake, obsolescence of project technology, a catastrophic accident at a project site or otherwise, risk-averse minority investors sometimes take comfort in a provision that requires the project entity to repurchase and retire its equity interest for nominal consideration (such as $1) and terminate the ongoing obligations of the exiting minority investor under the project agreements. This mechanism, known as the ‘nominal put’ option, is not usually sufficient to shield an exiting minority investor from all types of historical liabilities of the project, absent a release of claims, but it can offer a minority investor a clear path out of the project when time is of the essence, such as a situation where remaining affiliated with a project could cause severe reputational harm, for example.
Maximum liability cap
Most investors will want to ensure there is a finite maximum on their potential liability in connection with the project’s operations, as well as on the amount of capital contributions they may be required to fund to the project over its lifetime. This may be accomplished by ensuring the project documentation clearly provides that each investor’s obligation to contribute funds is several, but not joint, and capped at a fixed, agreed upon amount, unless otherwise consented to in writing. Further, it is integral for minority investors to ensure that that they cannot become required to guarantee any debt of the project in excess of an agreed amount, which is typically prorated in accordance with its proportional ownership interest in the project.
These protections are some of the most critical considerations for minority investors in structuring project joint ventures, but these considerations are not exhaustive of the risks inherent in the project development process. Investors of all types would be wise to carefully screen and select only the most experienced advisers as they confront the usual types of risks in an increasingly unusual macroeconomic environment.