When an individual or entity borrows money from another, it is a usual practice that the lender will require some kind of security. In the case of project finance, one of the securities that lenders ask from borrowers is the DSRA.
What is a DSRA in project finance?
Project finance is the financing of long-term and capital-intensive projects, such as infrastructure and other development projects. In such projects, capital used by developers or contractors is borrowed from lenders (e.g., banks and financial institutions).
To secure payment of these loaned amounts, the DSRA is established. DSRA, or Debt Service Reserve Account, is a reserve account that is set aside for the payment of any liabilities, such as debts, when such liabilities cannot be paid on time.
DSRA are highly preferred when doing project finance since the loaned amounts or debts are a non-recourse to the project owners. This means that the lenders cannot run after the project owners for the debts’ non-payment. As such, the development project must pay for these debts either through its revenues, or through the DSRA.
This is set up by the borrower in a project finance, as required by the lender. This will ensure the lender that the borrower has enough funds to cover any future debt. In other words, it’s a cash reserve that works as an additional security measure on the part of the lender.
To establish a DSRA in project finance, debt payments for the next 6 or 12 months are predicted or estimated. The amount arrived at is placed into a separate account.
Advantages
First, the DSRA provides some leeway whenever funds become short. For example, when there are other issues that need funding, the payment of borrowed capital and interest is still secured. As such, both are addressed in a timely manner without sacrificing the other.
Second, the DSRA in project finance is a risk-mitigating measure. By the nature of project finance, various risks and delays may arise during its implementation. One of the ways in troubleshooting these risks is by establishing a DSRA, as it ensures the financial stability of the project until its full payment.
Third, and is the most important advantage, the DSRA protects parties in the project finance. On the part of the lender, they are assured of the debt payment. While on the part of the borrower, it can rest easy that shortfalls in debt payment can be properly addressed.
Other security
Aside from establishing a DSRA in project finance, parties can agree to other forms of securities. This may depend on the project finance being undertaken.
Other forms of securities include:
- Debentures
- Bankers’ acceptances
- Promissory notes
- Share pledges
- Other security on specific assets
Is DSRA an asset or liability?
Although the DSRA in a project finance is used to pay the borrower’s principal and interest liabilities, it is part of its current assets in its balance sheet.
However, borrowers must be wary of the interest rates when they borrow funds to establish the DSRA. Here, the DSRA may practically become a “liability” when the interest for the borrowed funds is higher compared to the interest rates that the DSRA funds earn.
Watch this video to know more about the funding of DSRAs:
To know more about DSRA in project finance, contact a project finance lawyer in your area. If you’re from Vancouver, get in touch with one of the Lexpert-Ranked best project finance lawyers in British Columbia.
Who funds DSRA?
The DSRA in a project finance is typically funded by a combination of debt and equity. Once the debt increases, the DSRA must also increase to reflect the increase in principal and interest payments.
As to the source of the funds, this can be:
- Fully funded (on a fixed amount) at the end of the construction (with a set date) by lenders through a debt service facility, or by lenders and other sponsors; or
- Fully funded from the completed project’s revenues, by setting a schedule or periodic intervals with a fixed amount and set dates of payment; or
- Partially at the end of the construction by lenders and sponsors, and by the completed project’s revenues over time.
This will entirely depend on the agreement of the borrower and the lender. It can be shown in the credit agreement clause establishing the DSRA in the parties’ contract.
How is a DSRA created?
The DSRA is typically created just shortly before the loan becomes payable. Because project finance usually takes time to finish, the DSRA is commonly funded when construction period nears its end.
Depending on the agreement between both parties, the lender would have enough control over the account established for the DSRA.
As to the amount of the DSRA, it must be equal to the total sum of the projected principal and interest payments over the next 6 or 12 months, depending on the agreement of the parties.
In addition, when the debts increase, additional funds must be put in the DSRA. In the same vein, when the debts decrease, funds can also be withdrawn from the DSRA.
Lenders also do not benefit from any excess from the DSRA, since this goes back to the owners of such funds. What’s important for the lenders is that they get paid by the borrower, the project, or the DSRA.
Are there Canadian laws involved in DSRA?
Security interests, such as the DSRA in project finance, are covered by provincial laws on Personal Property Security Act (PPSA). Each province in Canada has its own PPSA, while the provisions of the Civil Code of Québec will apply in lieu of Québec’s “PPSA”.
Under these laws, making a valid security interest in bank accounts is done by registering a PPSA financing statement. It can be registered in the jurisdiction where the borrower is located.
Notice is not required to make valid security interests, but it may be required when the secured creditor (the lender) is expecting payment.
Interested in setting up a DSRA for your project finance? Call up any of the best project finance lawyers in Canada as ranked by Lexpert.