A cost overrun facility is a committed source of pre-completion funding sized to cover construction cost increases above the base budget and contingency. It is a form of completion support, distinct from contingency reserves, working capital, or liquidated damages. Lenders treat it as a liquidity backstop that ensures senior debt is protected through project completion, without increasing senior loan commitments. Terms typically define funding triggers, availability period, and sponsor obligations, aligning the facility strictly with overruns rather than broader project risks.
During construction, the facility ranks behind senior construction debt in cash flow and ahead of ordinary equity distributions. It is drawn for incremental overruns after the project has used contingency.
Common variants include contingent equity, a subordinated shareholder loan with payment-in-kind interest until completion, a bank or surety letter of credit in favor of the project, and a parent completion guarantee with an agreed cap. For completion testing, lenders insist the full undrawn amount counts as available funding. Documents express this through a direct obligation to fund when triggers occur.
Common law practice often relies on sponsor support undertakings, equity contribution agreements, and letter-of-credit backed facilities governed by New York or English law. A Sponsor Support Agreement obliges the sponsor to fund all or a capped portion of overruns and shortfalls needed to meet completion tests. The obligation sits at the parent rather than the project company. This supports limited recourse. Letter of credit structures place an LC with the security agent and link draw mechanics to certifications from the independent engineer.
In civil law markets, local concepts and regulatory rules shape the form. Sponsor commitments may be framed as a guarantee under the civil code. Some markets favor surety bonds over LCs for cost reasons, with terms governed by local insurance law. Where construction risk is high and markets are thin, multilaterals and export credit agencies may require broader completion support that functions like an expanded equity commitment.
Bankruptcy remoteness is preserved by keeping the overrun obligation outside the project vehicle. The project company receives cash only after a formal call. Intercreditor arrangements capture the subordination of any funded support and prevent leakage to sponsors while senior lenders are at risk. For clarity on structural considerations at the project company level, see this overview of the special purpose vehicle.
Triggers should be objective and early. Typical triggers for cost overrun facilities include a forecast overrun where the independent engineer certifies that the estimate at completion exceeds the remaining budget plus contingency, schedule slippage that compresses float and causes a pre-completion funding gap even after delay recoveries, and change orders or claims that move the estimate above budget after contractor responsibility is applied. Where hedging is incomplete, adverse foreign exchange or commodity moves can push the estimate over the threshold. An insured event that produces delayed proceeds can create a temporary funding gap as well.
The facility is callable after contingency is fully allocated and after the project has enforced contractor obligations. Funding must be available even if the cause is disputed. Repayment between sponsor and contractor can be sorted later. Lenders generally resist carve-outs other than defined force majeure and change in law where the financing package already delivers time relief or tariff adjustment.
Before close, the independent engineer assesses the base budget and contingency and recommends the size of the overrun facility. At close, the sponsor delivers the signed support package and, if relevant, an LC with headroom for fees through the construction period. The draw process follows standard disbursement mechanics.
The project issues a funding request supported by the independent engineer’s certificate and an updated sources and uses statement. Lenders’ technical advisors and model reviewers test eligibility and confirm that only agreed cost categories are covered. The security agent then issues a draw notice to the sponsor or to the LC bank. Funds flow into the construction account and are applied under the waterfall.
Ordering during construction is typically insurance proceeds and contractor liquidated damages first, then contingency, then the overrun facility, then senior debt. Post completion, any overrun drawings remain subordinated debt or are treated as equity, with distributions subject to operating metrics. For visibility on cash priorities and distribution ordering, see this primer on the distribution waterfall. For broader modeling context, the guide to project finance modelling sets out the usual flow-of-funds logic.
A typical package includes a Sponsor Support or Equity Contribution Agreement that defines the obligation to fund, the cap, triggers, and the form of funding. If there is an LC, there will be an LC Facility Agreement and a reimbursement agreement at the sponsor level that defines issuance conditions, reimbursement, collateral, and events of default. A completion guarantee may be a standalone document or folded into sponsor support. The Common Terms Agreement and Intercreditor Agreement embed subordination, turnover, standstill, waterfall, and application of proceeds.
Construction direct agreements align notice and cure periods and connect change order, liquidated damages, and force majeure treatment to the financing. Insurance endorsements assign proceeds to the security agent and coordinate claims timing. The accounts agreement and security documents control cash and grant security interests over accounts, including the proceeds of overrun drawings. Conditions precedent include LC delivery, corporate approvals, and legal opinions on enforceability.
Economics for cost overrun facilities vary by form. Contingent equity usually carries no cash coupon. Commitment fees on undrawn amounts often range from 25 to 100 basis points per year during construction. Upfront fees at close are similar. If drawn, the contribution is treated as equity with distributions after completion.
Subordinated overrun loans may have a commitment fee in the same range and a payment-in-kind margin of 400 to 800 basis points during construction. The margin can step down after completion or be repaid through cash sweeps. Letters of credit typically carry fees of 100 to 300 basis points per year on face amount, paid by the sponsor or the project. If the LC is drawn, the reimbursement obligation sits with the sponsor at its unsecured cost of funds plus a spread.
An illustration helps. Suppose a budget of 1,000 for direct and indirect construction costs, a contingency of 70, and an overrun facility of 100. If the estimate rises by 120 and liquidated damages and insurance total 20, the shortfall is 100. The overrun facility funds the full amount. Senior commitments do not rise. If the facility was an LC at 1.5 percent for two years, the sponsor pays 3 in fees. If the facility was a subordinated loan at 6 percent for one year, accrued PIK interest would be 6 and would be repaid after completion subject to operating tests.
Senior lenders expect the overrun facility to share collateral on a subordinated basis. If the support is equity, the protection is indirect through cash control and dividend blocking. If structured as subordinated debt, the provider signs the intercreditor agreement. Payment blockages, turnover of recoveries, and cure rights are set out there. LC proceeds go to the security agent and are applied under the construction waterfall. Reimbursement claims sit outside the project security package unless expressly included.
Consent rights require care. Sponsors resist giving subordinated providers votes on senior amendments. Lenders resist sponsor approval rights on enforcement. The limited set of decisions that change the cap or the triggers on the overrun facility can require sponsor consent.
Sizing starts with budget validation by the independent engineer. This often takes four to six weeks. The term sheet then defines form, cap, fees, ranking, triggers, and treatment after completion. Documentation follows. Parties negotiate carve outs, insurance endorsements, and construction alignment. Sponsor boards approve contingent obligations. LC banks set issuance limits. Lenders approve completion risk. Closing deliverables include reliance letters, executable LCs, legal opinions, accounts control, and conditions precedent.
During construction, the engineer provides monthly updates, the agent tests notice mechanics, and sponsor teams rehearse funding calls. Where equity cures will be part of covenant testing after completion, the mechanics should be clear. For background on how cures work in credit documents, see this primer on equity cure provisions.
Certain failures repeat. Ambiguous lines between overruns and scope changes create disputes while the project needs cash. Draft clear rules for elective changes, omissions, and latent defects. A call right that requires sponsor consent is not a call right. Use independent engineer certification and objective thresholds. LC terms that allow banks to block draws over disputes defeat the point. Use demand based LCs with a narrow fraud exception.
Sizing that ignores owner’s costs, escalation, foreign exchange, and time related costs risks shortfall. Size to total sources and uses rather than EPC alone. Governance that conveys power over relevant activities can create consolidation surprises. Draft protective rights, not operating control. Tax leakage can arise if PIK interest is not deductible or if hybrid rules apply. Align construction direct agreements and intercreditor timelines so step in and cure periods match. Anticipate insurance timing gaps and allow the facility to bridge to collection.
Fast screens help. If the independent engineer cannot certify a credible budget and schedule with quantified float and risk allowances, a modest overrun facility will not solve the problem. If the sponsor cannot provide an LC or guarantee sized to economic risk with a strong issuer, the capital structure needs a rethink.
If performance security and liquidated damages are small relative to time exposure, assume the facility will be called and price it. If material permitting or change in law risk is unresolved, size up or secure regulatory cushions before close. Where lenders want a simple test of operating resilience before distributions, the debt service coverage ratio threshold after completion should be set with care.
Lenders underwrite capacity and willingness to fund. Capacity is about liquidity, available LC headroom, and legal authority to issue guarantees. Willingness is about cap size relative to equity at risk, cross defaults to corporate debt, and conditions precedent to funding. Analysts review sponsor covenants to avoid conflicts with guarantee issuance or reimbursement.
Where sponsors are funds, lenders often require back to back commitments from fund vehicles with capital call mechanics that are proven and with investor side letters pledged. For corporate sponsors, a parent guarantee across relevant obligors avoids ring fencing that could frustrate calls. LC banks and sureties conduct their own diligence. Their participation signals an extra layer of credit review if terms are aligned.
Enforcement should be simple. Notice mechanics should allow the security agent to call the facility without multiple consents. Dispute resolution should fit the law and forum chosen for the senior facilities. If a sponsor contests a call, LC proceeds should still be available to keep the project moving while issues are settled. After completion, funded amounts are repaid or convert per the agreed terms. Cash sweeps may apply until the project posts agreed operating metrics for several quarters. Unpaid accrued PIK interest on subordinated drawings should not block completion tests.
Cost overrun facilities provide callable funding on objective triggers and enforceable obligations, ensuring completion support without increasing senior debt.
Form is secondary to structure. Contingent equity, subordinated loans, or LC backed support must be sized correctly, drafted tightly, and aligned with intercreditor and construction terms. Weak sizing, vague triggers, or sponsor vetoes negate their purpose.
For credit committees, the standard is straightforward: immediate, unconditional liquidity in a downside scenario. Sponsors that meet this test close with more resilient capital structures and stronger lender confidence.
P.S. – Check out our Premium Resources for more valuable content and tools to help you break into the industry.
