Risk of loss
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This article is written by Raghav Madan, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. The article has been edited by Ruchika Mohapatra (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).


Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure through debt and equity, which are repaid from the cash flow generated from the project. Due to this reason, there always exists a scope of uncertainty and risks like demand risk, construction and completion risks, political risk etc. As a result, managing risks becomes very important to ensure the successful completion of the project in a cost-effective manner. This article will deal with the concept of risk allocation in project finance and the specific risks that exist at different stages.

Few key parties involved in this risk are as follows

  1. Project Sponsors who subscribe a significant proportion of equity shares in the project vehicle.
  2. Project Vehicle selects and appoints all the project contractors, negotiates and executes the contracts, raises the financing, supervises constructions and commissioning, and operates the project either directly or through an Operations and Maintenance (O&M) Contractors.
  3. Lender to provide debt to finance the construction of the project. Typically, a consortium of lenders, led by the “Lead Bank”, ascertains a bankable project cost and in consultations with the SPV and the project sponsors a “Means of Finance”.
  4. EPC Contractor(Engineering, Procurement and Construction Contractor) designs the project, procures all the engineering skills and equipment to construct the project, erects all the project facilities, conducts tests and trial runs.
  5. O&M Contractor is responsible for operating and maintaining the plant in line. Performance parameters that need to be achieved during operations are pre-defined in an O&M Contract.
  6. Off-Taker buys the product or service that is to be produced by the project. Off-taker can be an independent third party or an affiliate of the project sponsor.
  7. The government would provide a concession to the Special Purpose Vehicle to set up the project and ensure that a proper legislative and regulatory framework exists that allows the concerned Special Purpose Vehicle.

Generally, it is seen that efficient and structured allocation of these risks are given to the parties that are most capable of managing them which thereby makes project finance beneficial for all the parties. Now that we have discussed the parties involved in the project finance risks, let us understand how it is allocated.

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Project-specific risks

The project-specific risks can be better understood by way of the project lifecycle through 3 stages which are as follows:

Stage 1 : project development

Under this stage, the project sponsors have to carry out technical and economic evaluations in order to judge whether the project is feasible or not. They need to obtain all the necessary permits and acquire the land on which the project is supposed to be built. It includes preliminary economic assessment, feasibility study, license acquisition, land acquisition, financing arrangements, etc. This phase takes anywhere around 3 to 10 years depending upon the industry and project.

These tasks are costly as multiple consultants would be employed by the project sponsors to carry out these tasks. At this stage, the sponsors are yet to find out whether the project would be able to raise necessary finance or not. So, the risk is majorly on project sponsors and it is their industry expertise and project finance transaction experience which can really mitigate the risks at the development stage.

Stage 2 : construction

At the construction stage, an EPC Contractor designs the project as well as procures necessary equipment and materials. He builds the project according to the specification set out by the Project Sponsor. The Construction stage lasts from 1 (one) to 5 (five) years depending upon the complexity of the project. 

When the project enters the construction stage, there are mainly 3 risks:

a. Delay risk

Delay of the project is one of the biggest risks in project finance since it can have a domino effect on other factors. This is because: 

  • If the project is delayed, the lenders will not be paid the agreed debt repayment within the provided time;
  • The buyers will not be given the project’s output within the provided time;
  • The suppliers to the project will not sell the product as per agreement;

And the list of problems will continue. Project finance is a very structured transaction where every activity/conduct is dependent on the other. Even a small hindrance at any point can cause chain effects which may generate a multi-crore rupees liability (depending upon the terms of the agreement) and therefore requires careful diligence.

This risk is dealt with through an EPC Contract (Engineering, Procurement and Construction Contract) where EPC contractors will have to pay penalties to the project company for each day the project completion is delayed. These penalties are usually equivalent to the costs that Project Company incurs including the cost of lost opportunities. 

Project completion risks under the EPC Contract provide a completion guarantee and this guarantee is typically backed by an independent bank.

b. Performance of the project

Performance risk means that the project has to perform as per the minimum standards laid down in the EPC Contract or better. If not, the project will not be able to produce planned output and generate planned cash flows which will adversely affect the ability to repay the debt and dividends.

Therefore, it is vital to have performance guarantees in the EPC Contract which again, is dealt with by the EPC Contractor whereby any short faults in the performance would be punished.

So fundamentally at the Construction Stage, the EPC Contractor takes the risks under a turnkey EPC Contract. Once the construction is completed and all necessary tests have been taken care of after which the project enters the operations stage.

Stage 3 : operations

At this stage, O&M Contractor takes over and is responsible for the execution of the project which includes activities like operation and management, revenue and supply of the project. Operations stage deals with typically 3 types of risks:

a. Revenue risks

The revenue risks are closely associated with the risk of lack of market for the project’s final outcome. And there are numerous methods to counter revenue risks. If the project has a few or only one buyer, the project typically enters into a “take or pay contract” with buyers. This means the buyer must purchase the provided quantity of the project’s output and at the provided price in the contract. The buyer must purchase the output when it is delivered. This type of contract generates a stable cash flow to the project company as there is no way the buyer can back out of such contracts. 

Moreover, in the case of multiple buyers (for example toll roads), mitigation of revenue risk is done through either govt. support where the govt. provides some minimum payments to the project to cover the project’s fixed costs and debt repayments in case revenue does not meet the planned amount. Such governmental support would only be available if the project is being developed as a concession project or the revenue risk can be mitigated through detailed market studies.

Therefore, it is either the government under concession agreement or Sponsors and Lenders that take revenue risk. 

b. Supply risk

Supply risk deals with the necessary amount of raw material that is to be supplied to the project at a provided cost in the Supply Contract. They manage this risk through “put or pay contracts” (a party agrees to supply raw material for a certain price during a certain period and agrees to pay for an alternative supply in case it fails to perform). Such risk is taken by the raw material suppliers.

c. Regular maintenance

The O&M Contractor is responsible for the regular maintenance of the facility and receives variable payments for services agreed in the O&M Contract. However, if the maintenance of the project is not up to the standards (through regular checks), penalties (after due consideration to the situation) will be applied to the O&M Contractors. As a result, O&M Contractor bears such risk.

Macroeconomic risks

Macroeconomic risks include:


Inflation is generally a pass-through to the project off-taker. This typically includes price escalation in the off-take and supply contracts. Accordingly, the increase in the supply cost is according to the escalation formula as per the Off-take agreement for which an off-taker is responsible.

Exchange rate

The exchange rate risk arrives from the fact that financing cost is almost always in some kind of hard currency and revenue is in local currency. And in the case of countries like India (where local currency tends to depreciate overtime), the project company would have a hard time repaying the debt which would hamper the value of returns. 

Exchange rate risks can sometimes be hedged. However, if hedging is not available, it is possible to quote the price of the product or service in the hard currency and thus avoid the exchange rate risks. 

Of course, in the end, off-takers take the risk of the exchange risk. Often in concession projects, the exchange rate risks are taken by the govt. which compensates the project company to bear any losses through adverse exchange rates. 

Political risks

Political risks arise from the government through some key legislative decisions such as cancellation of a project, change in the terms of the contract, regulatory risks, or even a risk of nationalization of the project. 

Some of this risk is mitigated through project agreements with the government but not all political risks are likely to be borne by the government. Sometimes, commercial lenders also bear the political risk to a certain degree. 

As clearly visible, the commercial insurance market absorbs a very limited degree of true political risk. This is why many Project Sponsors have turned to export credit agencies to shoulder some or all of this burden.

Social risks

Infrastructure projects have an important impact on local communities and quality of life (in particular delivery of essential services like water and electricity or land-intensive projects like toll roads) that could result in resistance from local interest groups thereby leading to delay in project implementation and increase the cost of execution and shake project viability. The lenders and project companies often look to the grantor to manage this risk. 

Force majeure 

It is important to note that the financing agreements may not always include force majeure (considering they were not given due importance before the pandemic). As a result, the obligation to pay these loans will continue in the event of force majeure or change in the law. Such clauses are carefully looked at by the Lenders and influence their decision making.  As a result, this risk needs to be allocated to the party. Usually, these are covered by an insurance company.

Mentioned in the table below are outlined the major risks that a project faces in typical risks allocation in project finance.

RisksMajor Burden
Project DevelopmentSponsors
ConstructionEPC Contractor
SupplyRaw Material Supplier
Operational and Performance RiskO&M Contractor
Macroeconomic RiskOff-Taker
Political RiskGovernment & Export Credit Agency
Social RisksGrantor
Force MajeureInsurance Company

The above-stated risks are general in nature and the burden to bear these risks vary from situation to situation. They can vary based on:

  1. The nature of the project;
  2. Location and jurisdiction of the project;
  3. Parties involved and their ability to bear such risks;
  4. Applicable laws;
  5. Negotiation between the parties.


Project financing involves multiple parties like Financial Sponsors, Lenders, O&M Contractors and even govt. amongst the few. The nature of Project Finance is based on long-term borrowings and generally, these risks are given to the party that is most capable of handling it. However, there are many shortcomings in risk analysis and risk allocation which may result in project failure. 

This is where risk analysis becomes vital and requires due diligence. As a result, risk allocation becomes vital for the project’s success and a favourable outcome. It is the efficient and structured allocation of these project-related risks such as political risks, macroeconomic risks, etc. which makes project finance beneficial for all the parties.


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