An infrastructure project is only feasible if it is capable to be financed. However, one of the major obstacles for infrastructure development is precisely the availability of capital to a private stakeholder. Even in such cases where private stakeholders participate in a project with sufficient capital of their own, they will seek third party financing because it is more efficient to finance a project with capital belonging to others than with one’s own capital.
The following sources of financing applicable to projects are generally available in Ecuador:
- Third party financing through indebtedness deriving from (i) loan agreements, (ii) issuance of corporate bonds as commercial debentures, (iii) securitization of assets, (iv) foreign trade structures.
- Own financing through capital contributed by shareholders or related parties, whether such financing is registered as (i) capital, (ii) equity, or (iii) an account payable by the company to shareholders or related parties.
Usually, project financing requires a mix of own capital and third party capital. The reason for this is that intensive capital requirements during the first stages are more efficiently financed through third party participation, and because third parties request to evidence their capital contribution to demonstrate the commitment of the shareholders or the project’s sponsors.
When a debt granted by third parties coexists with the shareholders’ own capital financing, the financiers usually impose – among their financing conditions – that the company’s obligations towards its direct or indirect shareholders be converted into subordinated debt, namely, into a debt that can only be enforceable when the principal debt with the financiers has been paid up.
From a financial standpoint, loans or contributions from direct or indirect shareholders of a company participating in a financing project – which are converted into subordinated debt – are riskier obligations because they will be recovered in a longer term, and this will only happen when the financiers who granted the principal loans have been paid up.
Since there are greater risks in subordinated loans, it is understandable that direct or indirect shareholders – the creditors of the subordinated debt – will demand an interest rate greater than the once required by creditors who are beneficiaries of the principal loan.
In this regard, the Law on Public-Private Alliances has established a new mechanism for developing public-private projects. For instance, it created tax exemptions on payments of capital, interest and even commissions relating to external financing in the specific case of public-private alliances.
The Law on Public-Private Alliances also establishes benefits regarding subordinated credits. It amended the Law Amending Tax Equity in Ecuador by providing that payments for subordinated credits sent abroad will be exempted from the currency remittance tax. However, this benefit is conditioned on that the recipient of those credits should not be in a subcapitalization situation (i.e. that all credits received from related parties must not exceed 300% of the recipient’s equity) and that the credit ought not to exceed the reference interest rate on the date the credit is granted.
Unfortunately, the following aspects have been left out from the analysis: (i) That infrastructure projects require substantial amounts of own capital by way of loans which in the first stage of the project will surely be much greater than 300% of the equity of the company participating in the investment project; and (ii) that subordinated loans require an interest rate higher than the rate applied to normal credits.
Thus, at this point the content of the Law on Public-Private Alliances is far removed from reality and, therefore, it might not result into the same incentive on investments as it expects.
Warning: This newsletter by Pérez, Bustamante & Ponce is not and cannot be used as legal advice or opinion since it is merely of an informative nature.