Reaching financial close for a federal credit deal is no small feat, and frequently it falls to the legal teams to ensure that the business deal not only complies with the various federal requirements but is not hampered by any of those requirements. After several years working as a deal attorney at three different federal agencies, I have seen a few pitfalls in the deal papering process arise repeatedly – often leading to amendments (or even restructurings) post-closing. 

Whether you are an attorney supporting one of the many federal credit programs (or advising their borrowers or investees) or an impact fund manager or mission-driven organization layering federal debt into a blended finance deal, these four potential pitfalls should be on your radar. 

Pitfall #1: Not Considering the Social & Environmental Review Process 

The Pitfall: Failing to account for the social and environmental (S&E) review and compliance process when developing a project timeline.

Context: U.S.-based projects that are financed by a federal agency are subject to the National Environmental Policy Act. Similarly, non-U.S. based projects that are financed by a federal agency are subject to that agency’s S&E review process. In either case, for a greenfield project, this review can easily take months (or much longer), and the review must be completed prior to any disbursement of federal funds. In addition, oftentimes, the outcome of these reviews results in additional covenants being placed on the recipient which may also need to be completed prior to (full) disbursement of the federal credit. 

Why It Matters: Delay in completion of the S&E review (or in completion of any additional requirements that result from the review) could lead to unanticipated delays in receiving the federal funding, which in turn may adversely impact the project’s overall schedule and budget.

How to Address: 

• Stay engaged with the federal agency’s S&E review process, including promptly replying to any requests from the review team and regularly meeting with the review team.
• Consider locking in key credit terms in a binding term sheet (as opposed to skipping the term sheet and waiting to proceed to full credit documentation). Be sure to confirm with the federal agency team that the term is an “obligation”, and not just a commitment. 
• Build adequate (and then some) buffer into the project timeline and budget and make sure that timeline and budget flows through all the key project documents.

Pitfall #2: Including Aspirational ESG and Impact Metrics as Covenant Violations

The Pitfall: Including aspirational ESG and impact covenants as hard-coded covenants in the credit documents.

Context: Inclusion of covenants that require specific social, environmental, or development outcomes in the credit agreements for federal agencies (as well as DFIs, multilaterals, and impact funds) is market standard at this point. At times though, these agreements include both required covenants and aspirational goals as inflexible covenants, with the same outcomes (e.g., default) if they are not achieved. 

Why It Matters: Inclusion of aspirational goals as locked covenants in the credit agreement can put the federal credit recipient on a path to technical default if they are unable to comply with the covenant – setting all parties up later for the process of either waiving a default or amending a document (and the awkward conversations that are required to explain the rationale for why it is needed). 

How to Address: 

• Thoroughly consider each ESG covenant in the credit agreement and whether each covenant is achievable in the timeframe required; discuss any problematic covenants with the federal agency deal team prior to signing the credit documents.
• Make sure that all ESG covenants are drafted clearly with objective standards and measurements. 

Pitfall #3: Treating Federal Credit Programs as Private Debt

The Pitfall: Failing to appreciate the complexities that accompany obtaining federal credit.

Context: Federal credit programs are not conventional loans that happen to have a government lender. These programs are authorized by statute (for some, this authorization must be renewed from time-to-time), implemented through agency regulations, funded (oftentimes, annually) through the budget and appropriation process (which can layer on additional program terms and conditions), and then directed (in terms of funding priority) by each presidential administration. These layers of governmental influence impact many aspects of the transaction (e.g., eligibility requirements, disbursement conditions, covenants, reporting requirements, collateral requirements, etc.). 

Why It Matters: Given the complexities and intricacies of navigating federal credit programs, teams and advisors that lack experience with these programs often end up approaching the transaction as they would a private credit transaction – leading to protracted negotiations and ultimately increased time and expense in getting to financial close. 

How to Address: 

• Work with financial and legal advisors with federal credit experience, and ideally, experience with the federal agency providing the relevant funding.
• Familiarize yourself with the guidance manuals published by the relevant federal credit program.

Pitfall #4: Failing to Harmonize Federal and Fund Reporting Obligations

The Pitfall: Simply adding each credit provider’s reporting requirements into the credit documentation without analysis.

Context: Federal credit programs, as well as impact funds, private banks, and other credit providers each have a unique (and often, partially overlapping) set of reporting requirements, including reporting on finances, impact metrics, material issues, and project development and operation. For federal credit programs, some reporting requirements are statutory in origin and (fairly) non-negotiable in scope. Also, recipients of federal funding may be indirectly impacted by federal disclosure requirements that fall on the relevant agency, e.g., reporting to Congress, Freedom of Information Act (FOIA) requests.

Why It Matters: Satisfying reporting requirements from multiple parties can be burdensome, and reporting requirements that partially overlap can lead to inefficient use of time and resources. Additionally, it is possible that federal reporting or disclosure requirements may conflict with the confidentiality requirements of the recipient’s other investors. 

How to Address: 

• When drafting the credit documentation, harmonize the reporting requirements (in terms of scope and deadline) to the reporting requirements of the recipient’s existing creditors and investors.
• Ensure that the reporting requirements are reviewed and signed-off on by the internal teams that will be responsible for handling reporting.
• Keep FOIA in mind when disclosing (e.g., carving out confidential information into a separate section for ease of redaction).
• Ensure that any confidentiality requirements from non-federal creditors and investors accommodate any federal disclosure demands or requests.

Conclusion

Federal credit is a powerful, low-cost, and patient tool for financing impactful projects. However, these benefits come with statutory, regulatory and policy complexities. Attorneys and fund managers who understand the nuances of navigating federal credit intricacies will be able to spend less time unwinding problems that could have been avoided and more time doing the important of creating lasting impact in the communities and markets that need it most.

This article is intended to provide general information about obtaining federal credit and does not constitute legal advice. We encourage you to consult with an attorney for advice based on your specific circumstances. This article does not create an attorney-client relationship between ImpactGC and you or your company, or create any duties to provide advice with respect to obtaining federal credit. ImpactGC is not responsible for updating you or your company about developments regarding obtaining federal credit.

At ImpactGC, we stand at the intersection of legal expertise and purpose-driven business. We specialize in providing fractional general counsel services and transactional counsel services to impact investors (and their portfolio companies), B corporations, and other mission-driven enterprises – all at rates that are a fraction of the cost of hiring a full-time in-house counsel or engaging a traditional law firm.