Principles of Project Finance

Lenders therefore prefer overseas Reserve Accounts for projects in coun-

tries with poor credit ratings, but this may be difficult in countries with strict ex-

change controls, where domestic companies are not allowed to have such accounts

(cf. §7.4.2).

§10.4 EXPROPRIATION

A government always has the power and right to take over privately owned as-

sets temporarily where this is necessary for reasons of national security (for ex-

ample, states requisition ships and aircraft in time of war). Many countries have

also legislation that gives powers to take over or direct the actions of privately con-

trolled utilities, or divert oil or other fuel supplies, to maintain essential services.

Any investor or lender takes this risk, and in any case the government usually pro-

vides compensation for such actions.

Expropriation goes beyond this; it is the seizure by the Host Government of the

Project Company or its physical or financial assets without payment of just com-

pensation (which is illegal under international law). This is a risk that concerns

lenders and investors involved in projects in less politically stable countries. It is

greatest in high-profile projects that might otherwise be in public ownership, such

as power plants or transportation projects, or projects related to a country’s natu-

ral resources, such as oil or minerals (where such expropriations have been com-

mon in the past, but less so in recent times). Technically the Host Government

does not even need to deprive the Project Company of its assets or the investors of

their shares; for example, it could pass a law giving it the right to appoint a ma-

jority of the directors of the Project Company and so gain control in that way.

Expropriation of private assets for political reasons does not just affect cross-

border investors and lenders, but is primarily considered to be a cross-border risk

affecting loans to developing countries.

A Project Agreement or Government Support Agreement should treat expro-

priation as a default by the Offtaker or Contracting Authority, and therefore pro-

vide for compensation (through a Termination Sum) accordingly. Expropriation is

defined as widely as possible to include not just taking over the assets of the proj-

ect, but also actions that give the Host Government control of the Project Com-

pany. This may provide some deterrent to the Host Government acting arbitrarily

against the project. However, it does not deal with the issue of “creeping expro-

priation” discussed in §10.7.3.

It should be noted that there can be an overlap between expropriation and the

currency conversion and transfer risk discussed above, because the reason for the

Project Company being unable to convert or transfer its revenues in the host cur-

rency may be that its bank accounts have been expropriated (or frozen) by the Host

Government.

208 Chapter 10 Political Risks