Transcription
Hello and welcome everyone to the next in our series of mining-focused webinars. Today, we're looking at issues related to equipment financing, relevant in the mining sector. My name is Rachel Spate, and I'm part of the mining team here at Mayer Brown. And I'm joined by Anjali Sumanu, who's going to present largely today.
So, what are we talking about here? We're really talking about how mining projects can get financed in this day and age. Many people will be familiar with the difficulties of raising finance in the equity markets and from traditional debt sources. And that's meant that companies are having to look at a wide variety of ideas for how to finance their projects. And that means that they have to look at all their different assets for different ways of raising finance. So, equipment raises an interesting area where finance could be raised separate from the actual mining projects itself.
So today, in this session, we're going to look at some of the common structures used in mining equipment financing, the advantages and disadvantages in those structures, the risks that are inherent in some of those arrangements, the typical documentation involved, and some real-life examples.
So, setting the scene, mining equipment, we typically mean here is the high capital value equipment, so big pieces of yellow goods or heavy machinery and processing plants. And there's been an increasing demand in Africa, but in other mining projects, for that sort of mining equipment and the finance that goes with it. Particularly in some jurisdictions, they've recognized that in order to develop economically, you have to get the equipment in the country. So, some of this mining equipment, as people will be familiar, is manufactured in places like Japan, South Korea, the US, and elsewhere. And there's often some interesting ways of gaining access to export finance solutions through those geographies.
So, the aim of this session is really to consider ways in which financiers may be able to support businesses, mining businesses in particular, by providing finance for the purchase of this sort of equipment. So, customers requiring mining finance equipment will consider a mixture of structures that could be driven by tax considerations or cost considerations or a variety of different decisions.
So, I'm going to hand over now to Anjali, who's going to take us through each of those structures in detail.
Anjali, thanks Rachel, and hello to our listeners. As Rachel said, I'm going to run through some of the common structures we see used for financing equipment in the mining space and talk through their key features and advantages and disadvantages.
So, this slide sets out the four main structures I will cover. We have secured lending, where a financier provides a loan to a borrower for the purpose of purchasing mining equipment. Finance leasing, where the financier itself would purchase the mining equipment and then lease it out to the end user. Combined secured lending and leasing. This is a kind of hybrid of the above two structures. So, the financier here would provide a loan to a middle company or a special purpose vehicle, and that middle entity would purchase the equipment with the loan and then lease it out to the end user. Finally, we have the ECA buyer credit structure. This is essentially the same as the secured lending, except that the financier's loan to the end user would be backed by an ECA guarantee or ECA insurance.
So, taking secured lending. This is the most conventional of the structures, where a lender provides an equipment finance loan facility to a borrower, who is the end user of the mining equipment. The borrower draws down on the loan to purchase the mining equipment it needs and makes repayments of principal plus interest to the lender. In a typical scenario, the lender will take security over the purchased mining equipment, as well as various contractual rights relating to the equipment.
Those listeners may be aware, creating, perfecting, and enforcing security can come with challenges and nuances across jurisdictions. Depending on the borrower's jurisdiction, there may be restrictions on taking security over movable assets such as mining equipment, or even where you can easily take security. There may be difficulties or costs associated with perfecting the security, and by that, we mean ensuring that it is effective not only against the borrower but also against third parties. For example, so that a third-party lender cannot purport to take security over the same asset and claim priority over the equipment financier's interest, and so that a third party cannot purchase the mining equipment from the borrower free of the equipment lender's security interest.
The methods of achieving perfection and priority ranking differ across jurisdictions. In some jurisdictions, the mining equipment might need to be physically marked to show the lender's interest. In other jurisdictions, registration may be required, and this can come with costs and administrative burdens. Lenders also need to consider how quick and easy it will be in a given jurisdiction to enforce their security should they need to arise. For example, although the borrower may have agreed in the security agreement that the lender can come and take possession of the mining equipment following an event of default, such as a failure to pay, local laws may require the lender to obtain a court order before it can take possession, and this would obviously add time and cost to the enforcement process.
Now, it depends, of course, on the structure and facts of each transaction, but oftentimes in these secured mining equipment finance facilities, the lender's main recourse will be to the mining equipment itself. Stronger borrowers will resist providing parent guarantees, and the other assets of the borrower will likely be subject to prior-ranking security in favor of other lenders, such as the main project lenders or corporate lenders. Usually, though, the equipment is ring-fenced for the benefit of the equipment financier only, so that those other lenders to the borrower would not have the benefit of any security over it. And this can be spelled out in the inter-creditor arrangements.
So, since the equipment financier's main recourse is probably going to be to the mining equipment, the financier will be particularly interested in having protections in place to ensure that the value of the equipment is maintained as far as possible, so that in an enforcement scenario, where the lender has to repossess and sell the mining equipment, it will have a greater chance of recovering its losses. The facility agreement will typically include a loan-to-value covenant, a borrower's undertaking to ensure that the equipment is maintained and insured, restrictions on the borrower subletting the equipment to third parties, and a right for the lender to conduct physical inspections of the equipment from time to time.
Aside from the security over the equipment itself, a lender will usually also take a security assignment of the borrower's rights under the equipment manufacturer's warranties. So, if the equipment is not fit for purpose and this results in a loss for the lender, in other words, the borrower is unable to use the equipment for its intended purpose and as a consequence is unable to repay the lender, then the idea is that the lender will have direct recourse to the manufacturer. The borrower is typically required to take out insurance cover against loss or damage to the mining equipment and to assign its rights under the policy to the lender or have the lender named as loss payee on the policy.
Depending on the type and complexity of the mining equipment, the borrower might enter into a maintenance contract with a third-party provider to maintain the equipment in good working order, and it may be required to assign its rights under these contracts to the lender as well, so that if the maintenance contractor fails to do its job, then the lender will have direct recourse under the maintenance contract. So, that really covers everything that's on this slide and is, I guess, secured lending in a nutshell.
Moving on to finance leasing. In this case, instead of granting a loan to the end user to purchase the mining equipment, the financier itself purchases the mining equipment its client needs and then leases it out to the client. The client, so the lessee, will make lease payments to the financier in installments, which will add up to the cost of the equipment plus funding costs for the financier. So, similar to loan repayments and margin in the secured lending structure.
In this structure, while the lessee has possession of the equipment for most of its useful life, the financier is the one who owns it. It follows then that the financier doesn't need to take any security over the equipment or over the manufacturer's warranties. The idea is that the financier, as owner of the equipment, should be able to take possession of it and sell it in an enforcement scenario.
In some jurisdictions, there may be a requirement or an option to register equipment which is the subject of a finance lease in a public registry, so that third parties are put on notice about the lessor's ownership interest. That way, if the lessee tries to sell the mining equipment to a third party in breach of the finance lease terms, then that third party should be aware, or it will be deemed to be aware, that the equipment is not the lessor's to sell, and the third party can't purport to have purchased it in good faith.
Lessors will usually have rights under the finance lease to regularly monitor or inspect the mining equipment, and the lease will prescribe the condition in which the lessee must return the equipment to the lessor at the end of the term. At the same time, the finance lease will probably include a right of the lessee to quiet enjoyment of the assets, in other words, without undue interference from the lessor. At the end of the lease term, the lessee will be required to return the asset to the lessor, and the lessor will then need to sell or dispose of it, or the lessee might have an option to purchase it.
Now, although the financier owns the assets, the lessee will typically be the one to take out the insurance cover and enter into maintenance contracts, and these will customarily be assigned by way of security to the lessor, as in the secured lending structure. The commercial effects of a secured loan and a finance lease structure are similar, but there will be considerations which might make one favorable over the other. Often, this is driven by tax. For example, depending on the jurisdictions of the end user and the financier, withholding tax might be payable on interest under loans. Income tax or VAT might be payable on risky to lease payments under finance leases.
Cross-border finance lease might be attractive where the financier is in a jurisdiction which grants generous taxes or capital allowances against acquisition costs of assets. Conversely, a cross-border loan might be better where the borrower's jurisdiction is more generous. There might be regulatory implications. For example, is a license required to conduct lending or leasing activity in a particular jurisdiction? Do you need to set up a separate entity to conduct such activity? Are there registration or other burdensome requirements associated with the financier owning mining equipment in a particular jurisdiction?
Security regimes are also a consideration. For example, if there is a real issue with taking or enforcing security over movable assets in a particular jurisdiction, it might make sense for the financier to own the asset instead, as in the finance lease structure. So, all things to discuss with local counsel in the relevant jurisdictions. And of course, the end user of the mining equipment may have a preference as to the structure they want to use. For example, do they want to purchase the equipment outright, or do they prefer to own it just for as long as they need it? Credit limits might be a consideration, since a lease is not a loan, any borrowing limit for a lessee should not be affected where the parties opt for a finance lease structure.
So, those are the types of things that financiers and borrowers or end users will need to think about and get specialist legal advice on when deciding whether to go for a lending or lease type structure.
The third structure we're covering today is a hybrid of the previous two, combined secured lending and finance leasing. Here, instead of the transaction being between the financier and the end user of the mining equipment directly, we have an entity in the middle who purchases the equipment using a loan from the financier and then leases the equipment to the end user. This structure might be used where the financier doesn't want to purchase, own, and lease the equipment, and so an SPV might be set up as an intermediate entity to take on that role. Alternatively, it might be used where the financier's customer isn't the end user of the mining equipment, but is actually itself an equipment financier who is looking for finance to fund its own leasing activity.
We've assumed on our structure chart here on this slide that the middle company is an SPV. The lender provides a secured loan to the SPV, who then purchases the mining equipment and leases it to the end user. So, the SPV is acting in two capacities here. It is the borrower under the mining equipment loan from the lender, and it's the lessor under the finance lease with the end user. The end user will make lease payments into an account of the SPV, which the SPV pledges in favor of the lender as security for its obligations under the loan. The SPV will also assign to the lender its rights against the end user under the finance lease. The SPV borrower, as owner of the mining equipment, will enter into insurance and maintenance contracts and grant security over them to the lender, along with security over the equipment itself and the manufacturer's warranties. Often in these structures, the SPV's parents will provide a corporate guarantee and a share pledge to the lender as well.
The security considerations are the same as those which I've mentioned in the case of secured lending. So, how do you take security in the jurisdiction of the asset? Bear in mind here we have account security as well. How do you perfect your interest against the borrower and third parties, and how quick and easy is enforcement? In terms of other pros and cons, the SPV will tend to be incorporated in a tax-neutral jurisdiction, and it will usually be only involved in the one transaction, making it insolvency remote. On the other side of the coin, there will be costs associated with setting up the SPV and just general complexity around having an intermediate entity involved in the transaction.
The final structure we wanted to cover is the Export Credit Agency or ECA buyer credit structure. Here, a lender provides a loan to a borrower to purchase mining equipment from an exporter in an ECA's jurisdiction, and the loan is backed by a guarantee or insurance from that ECA in return for a premium. Depending on the creditworthiness of the borrower, the lender might also require security in addition to the ECA guarantee or insurance, and the security in that case would be provided over the same assets as those in the secured lending structure, so security over the mining equipment, the manufacturer's warranties, insurances, and maintenance contracts.
Because of the involvement of the ECA, these transactions can take longer to negotiate. The ECA structure is likely to have to comply with OECD requirements for export finance. The ECA will prescribe reporting and inspection requirements, and its consent might be required for amendments and waivers in future, which is definitely something to bear in mind. Of course, the financing is limited to equipment manufactured in a certain jurisdiction, being the ECA jurisdiction, and the transaction will be subject to payment of an ECA premium.
The good thing about ECA-backed facilities, certainly from a borrower's perspective, is that often higher levels of debt can be achieved due to increased appetite from banks for ECA-backed financing versus traditional commercial financing. And ECA financing typically facilitates longer tenors in line with OECD guidelines. From a lender's perspective, ECA insurance tends to cover political risk, commercial risk, and interest rate risk, which can be a significant benefit in certain jurisdictions.
So, that was a bit of a canter through the four most commonly used structures we see. But of course, there are other structures or variations of these structures available, such as the operational lease, hire purchase arrangements, or a sale and leaseback, where the end user purchases the mining equipment, sells it to the financier, and then the financier leases it back to the end user. So, that's quite an interesting structure as well. Again, the right structure in a given scenario will depend on a number of factors, including tax, accounting, and legal considerations.
On this slide, we have set out for your reference some of the advantages and disadvantages which I've already addressed in relation to the four main structures discussed today. On this next slide, we have set out a summary of the risks and issues raised today. To recap, we discussed licensing requirements associated with lending and or leasing activity, registration requirements associated with ownership of mining equipment in certain jurisdictions, the hurdles around taking, perfecting, and enforcing security, tax and accounting implications of the structures, and a financier's interest in maintaining the value of financed mining equipment. We have discussed mitigants to those risks and issues, such as taking the benefit of insurance, obtaining appropriate legal advice, particularly in relation to local law and also tax advice when structuring the deal, ensuring security and ownership interests are adequately protected and, if necessary, disclosed, and including appropriate covenants and rights in the documentation.
And finally, to end on a case study, which is a real-life recent transaction we acted on, and we think it really brings to life some of the issues we've discussed today. So, our client here was a financial services provider who proposed to provide a secured loan to a mining company in Namibia to finance the purchase price of some mining equipment. The loan was going to be secured against the financed mining equipment. However, in Namibia, it wasn't possible to take non-possessory security over only a part of the borrower's movable assets. Security could only be taken over all of the movable assets of an entity. Since this mining company owned other assets which, by the way, were subject to security and negative pledges in favor of other creditors, including the main project finance lenders, it wasn't possible for it to provide this non-possessory security over all of its assets to our equipment lender, who only needed security over the equipment.
So, the initially proposed structure with the mining company as borrower was changed such that a new subsidiary was created solely for the purpose of purchasing and owning the financed equipment. So, this new subsidiary was now the borrower under the equipment finance facility provided by our client, and then the mining company guaranteed that borrower's obligations under the facility. The newly set-up borrower used the loan proceeds to purchase the mining equipment and then leased it to the mining company to use in its mining projects in Namibia. The borrower provided security over the equipment by way of a Namibian law general notarial bond, and this involved physically marking each piece of equipment to note the borrower's ownership and the lender's interest in it. Security also included an assignment of the manufacturer's warranties and insurances. The equipment-related covenants in the facility agreement were actually given by the mining company and not the borrower, because the mining company was the actual operator of the equipment, and then the borrower undertook to procure compliance by the mining company.
Our lender did look into a finance lease structure, but because it wasn't a registered entity in Namibia and it wasn't eligible to register as such, the lease would have attracted 15% VAT, which would have just made the transaction too expensive. And so, I think that's a really good example of how a local law security regime led the parties away from a simple secured lending structure, and then tax considerations were the driver for opting for a variation of the combined secured lending and lease structure over the simple finance lease structure.
And that brings us to the end of today's webcast. We hope that this has been a useful summary of some of the key financing structures in the mining equipment space. I'd like to thank you all for your time and hand you back to Rachel.
Thanks very much. Thanks, Anjali. That was really terrific. I hope everyone, that's given you a flavor for some of the complex structures that are involved in equipment financing and some of the pitfalls that you may come across. Here at Mayer Brown, we are very experienced in dealing with equipment finance, but also all other aspects of mining projects, how to get them built, how to get those financing solutions, and what happens when things go wrong. We have a footprint across the world, working on projects on various different continents. We'd love to talk to you about your mining projects. Please do get in touch. We are hearing of other webinars on various topics covering joint ventures, OHADA, and other aspects of the industry. If you've got some other ideas, please do get in touch. We'd love to hear from you. Thanks a lot. Bye.