Offtake Prepayment Financing

Producers, particularly those whose product lacks a terminal market to hedge against commodity price risk, may at some time want to look at an offtake prepayment to finance their project.

Essentially, an offtake prepayment arrangement is a loan - the offtaker provides the funding, typically on a secured basis, and that funding is repaid by delivery of product under the offtake agreement. It’s a payment for product in advance. These deals are usually done by a producer whose ability to access senior debt is constrained. Offtake prepayment can also be used in conjunction with senior debt to fill a middle ‘gap’ in the financing caused by a shortage of equity or senior debt. It can also act as a potential sweetener when proposed by an offtaker as part of a competitive tender process. And, in some jurisdictions, there may be tax incentives for a producer in pursuing this form of financing.

Prepayment terms

The terms of the prepayment need careful thought (these terms can either be incorporated in the offtake or be contained in a standalone facility agreement). Some terms normally required by a financier in a project loan agreement may not be appropriate for an offtaker. For example, it may not be appropriate for a producer to provide an offtaker with commercially sensitive operating information (but a bank, for example, will nearly always require this). Care also needs to be taken to ensure that covenants in the offtake prepayment do not have the potential to unintentionally cross-default to the senior debt. There is a multitude of technical points to consider.

Intercreditor arrangements

Where a senior project lender is involved, intercreditor arrangements have overriding importance. This is because the offtaker wears two hats: one as a purchaser of product and another as a subordinated lender.

The senior project financier will require any offtake debt to be subject to a subordination arrangement. Once production commences, the offtake debt will be reduced by delivery of product under the offtake agreement. Any other payments due to the offtaker will be made in accordance with the project financier’s payment waterfall. However, should a default continue in respect of the project debt, subordination of the offtake debt is triggered (and the offtake debt cannot be reduced until the project debt has been repaid). In those circumstances, the offtake agreement continues on a standalone basis (i.e. payment for product and subject to the terms of the tripartite/direct agreement with the project financier).

Agreeing Intercreditor Principles

As I’ve noted in a previous article, agreeing a set of intercreditor principles up front, and as early in the process as possible, leads to transactional efficiency and a better chance of a successful execution. Putting language into your offtake prepayment term sheet along the lines of the paragraph above can help that process along. Though, there are various other important issues that need to be considered. Wright Legal is WA’s only law firm specifically dedicated to banking and finance.