Project finance is one of the most sophisticated forms of commercial lending. It is used for large, capital-intensive, long-term infrastructure projects such as energy plants, transport systems, mining operations, telecommunications networks, and public-private partnerships (PPPs).
What makes project finance unique is its reliance on a special purpose vehicle (SPV), the non-recourse nature of the financing, and the heavy reliance on contractual risk allocation rather than traditional balance-sheet credit support.
Legally, it sits at the intersection of banking law, secured transactions, public law, construction law, environmental regulations, and international commercial contracting. This post explains how project finance works and the legal duties banks must observe.
1. The Core Legal Structure of Project Finance
1.1 The SPV as Borrower
Unlike corporate loans, the borrower is not the sponsor (the company promoting the project) but a newly created Special Purpose Vehicle whose sole purpose is:
Legally, the SPV is:
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bankruptcy-remote (isolated from sponsor insolvency),
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asset-ring-fenced (its assets cannot be used for unrelated obligations),
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governed by strict corporate rules to preserve separateness.
1.2 Non-recourse or limited-recourse lending
Banks rely primarily on:
Sponsors are not personally liable, except in limited situations (completion guarantees, equity commitments, wrongful conduct).
This transforms the bank’s due-diligence duties into strict legal obligations, because the bank must verify that the project can stand alone financially and legally.
2. The Contractual Matrix – The Heart of Legal Risk Allocation
Project finance is contract-driven, and each contract shifts specific risks.
2.1 Key contracts include:
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Concession / government licence
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Construction contract (EPC)
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Operation and maintenance (O&M) agreement
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Offtake agreement (e.g., Power Purchase Agreement)
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Supply contracts (fuel, feedstock, raw materials)
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Shareholders’ agreement
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Financing agreements
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Security documents
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Intercreditor agreements
Each contract has legal consequences for bank duties.
2.2 Principle: Risks must sit with the party best able to manage them
E.g.
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Construction delay → EPC contractor
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Volume/price risk → buyer/supplier
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Environmental compliance → SPV + operator
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Political risk → mitigated by government guarantees or multilaterals
Banks must ensure risk allocation is legally enforceable, not merely commercially desirable.
3. The Bank’s Legal Duties in Project Finance
Banks are not passive lenders; they hold several affirmative legal duties, arising from contract law, regulatory rules, tort principles, and international banking standards.
3.1 Duty of Due Diligence
Project finance requires rigorous due diligence. Legally, banks must examine:
Technical due diligence
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Construction methods
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Engineering feasibility
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Environmental risks
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Technology reliability
Financial due diligence
Legal due diligence
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Land rights and title
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Concession legality
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Corporate authorisations of SPV
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Enforceability of EPC/O&M contracts
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Sovereign immunity waivers
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Local law restrictions
The bank’s failure to perform adequate diligence may constitute:
3.2 Duty to Monitor and Ongoing Supervision
Even after disbursing funds, banks carry legal duties to monitor:
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construction progress,
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compliance with covenants,
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insurance requirements,
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budget adherence,
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environmental obligations,
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operational performance.
Monitoring is not optional—courts and regulators view it as essential to:
3.3 Fiduciary-like Obligations in Syndicated Loans
While banks are not trustees, in large syndicated project finance deals:
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The facility agent,
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The security trustee,
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The intercreditor agent,
may owe quasi-fiduciary duties to syndicate members.
These include:
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proper administration of loan documents,
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accurate reporting,
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equal treatment of lenders,
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impartial exercise of discretions.
Failure risks litigation and regulatory penalties.
3.4 Anti-Money Laundering (AML) and KYC Duties
Project finance often involves cross-border flows, sovereign entities, and politically exposed persons (PEPs).
Banks must comply with:
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stringent identity verification,
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monitoring of suspicious transactions,
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sanctions screening,
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enhanced due diligence for high-risk jurisdictions.
Failure triggers severe liabilities under AML laws.
3.5 Duty to Assess Environmental and Social Impacts (ESG Duties)
Modern banking regulation increasingly imposes:
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obligations to evaluate environmental risk,
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reporting under sustainability frameworks,
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compliance with local and international environmental laws,
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adoption of “Equator Principles”.
Banks may be liable for:
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financing unlawful activities,
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environmental damage linked to project operations,
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human-rights violations if due diligence is insufficient.
4. Security Package – Legal Framework and Enforcement
Project finance security is extensive, multi-layered, and jurisdiction-specific.
4.1 Common security rights
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Mortgage over project land
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Pledge/charge over shares in the SPV
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Assignment of receivables under the offtake agreement
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Pledge over bank accounts
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Security over equipment
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Assignment of insurances
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Step-in rights
4.2 Step-In Rights
Banks can “step in” and replace the operator if the SPV defaults.
Legally, this must comply with:
4.3 Enforcement
If the project defaults:
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banks may take control of the SPV,
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enforce security,
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transfer the project to new operators,
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or negotiate restructuring (common in energy/PPP projects).
Enforcement is complex because:
5. Government and Public-Law Interactions
Many project finance deals involve government counterparties.
Banks must understand:
5.1 Sovereign immunity
Governments may claim immunity unless expressly waived.
5.2 Administrative law limits
Some concessions cannot be freely assigned or pledged.
5.3 Public-interest obligations
Banks must ensure:
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tariffs comply with regulatory frameworks,
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service continuity is safeguarded,
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environmental permits are valid.
5.4 Political risk
Mitigated through:
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political risk insurance,
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World Bank/MIGA guarantees,
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stabilisation clauses,
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foreign investment treaties.
6. Interaction with Insolvency Law
Because the SPV is bankruptcy-remote, insolvency risk should theoretically be isolated.
In practice:
6.1 Recharacterisation risk
Courts may treat:
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security assignments as outright transfers,
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shareholder loans as equity,
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sponsor support as guarantees.
Banks must structure documents carefully to avoid legal reclassification.
6.2 Automatic stays
If the SPV does enter insolvency, local law determines:
6.3 Cash-flow waterfall protection
Banks rely on a contractual “waterfall” that dictates the order of payments:
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Operating expenses
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Taxes and fees
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Senior debt service
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Reserve accounts
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Junior/mezzanine debt
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Sponsor dividends
This waterfall must be legally robust to survive insolvency challenge.
7. Why Banks Must Take These Duties Seriously
Project finance deals often exceed hundreds of millions or billions of dollars, and their failure affects:
Therefore banking regulators impose unusually high standards of:
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prudence,
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compliance,
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documentation,
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risk management.
Banks that fail can face:
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regulatory sanctions,
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civil liability,
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reputational damage,
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loss of licence.
Conclusion
Project finance is one of the most legally intricate forms of lending.
It requires banks to:
Unlike ordinary corporate loans, project finance turns the bank into a guardian of public interest, environmental standards, and financial stability. The bank’s legal duties are therefore broad, stringent, and continuously evolving.
