Wednesday, December 10, 2008

IBT Fall 2008 Final Exam

In case anyone is interested, here is the text of my Fall 2008 final exam in International Business Transactions. I don’t think this was my greatest exam drafting exercise - I’ve done better in past years. This one is a little bit too much - well, a lot too much - stuffing issues in willy-nilly, without having pulled it together as a clever thing based around a discrete set of parties. This is done as a take home in which students have the full two weeks of exam period to do it, but a page limit of ten double spaced pages.

My IBT class is purely transactional - it moves briefly through a series of transactions ranging from cross border sale of goods to cross border services to cross border payment mechanisms such as LC to debt financing of these transactions to project finance to ... finally, joint venture and then exit strategy. All private transactions - no public capital markets, also nothing related to international trade as such, which is unusual for IBT courses even now. We use Vagts’s book, supplemented greatly by a series of photocopied contracts from my own work in international business transactions over the years. The final is usually based around something related to my pro bono practice that year with a nonprofit private equity fund that invests in independent media worldwide; this year I instead went back to a problem in housing finance involving a South African housing agency, a problem dating back to work I was involved in during the 1990s for a while.


Facts - Fall 2008 Anderson IBT Final Take-home Exam

(These facts are all made up. Not true! Libelous, probably!)

You are both general counsel and financial advisor to GoodWell, a financial consulting firm based in Washington DC that offers advice and financial planning, as well as a lot of deal consulting and brokering, for wealthy individuals, philanthropies, corporations and especially corporate charitable foundations, private equity firms and hedge funds that are looking to do transactions in the developing world. Typically these transactions involve a combination of for-profit motives on the part of some parties and non-profit charitable motives on the part of other parties – and sometimes both kinds of motives in the same party. Your business model as a consultancy is based around the concept of “Doing Good and Doing Well.” Although you privately have some questions about whether it is possible to combine those in the same deal, especially after looking at what happened to Fannie Mae, your business consists of brokering transactions and advising on them in both a business and legal capacity. GoodWell is a small firm and everyone on the staff has to play combined roles – hence your role involves both the general counsel as well as financial advising/financial structuring functions.

During the previous 18 months before the global market crash got seriously underway, GoodWell had been working closely with multiple parties, in the United States, in Western Europe, and in South Africa to close a deal in South Africa addressing housing in the Soweto townships. The parties involved in negotiations include developed world charitable foundations, for profit corporations, banks, and, in South Africa, the SA government, as well as government chartered but technically private housing agency called Nurcha that will act as the primary agency for doing the whole transaction. The aim of these negotiations is to produce some set of transactions that would fund the building of basic housing in the townships – on a very basic level: a concrete foundation on which the owners would gradually build their own dwelling as they could afford it, but most importantly water, sewage, and electrical connections.

The ultimate aim of these transactions is to produce, when all is said and done, this basic housing structure for local Soweto residents that they own and pay for over a twenty year period through a basic mortgage. The goal is 200,000 housing units and the associated utility services over a five year period. Working backwards from that goal, however, there are many intermediate goals that must be met. The main recipient of funds – donated funds as well as the primary borrower on loans – will be Nurcha, acting as a private entity organized as a not for profit corporation in SA.

The housing work must be performed by local contractors – Soweto has a well established local contractor, SA Builders, that can both perform the work and also subcontract and supervise three other smaller contractors. They are excited, of course, about the possibility of at least five years worth of work, but they also have concerns about whether the promised financing will really be there over the five year period to pay them – they have had experience with foreign development groups before that promised programs of a certain number of years that bailed out midway through. Nurcha and the SA government agencies, for their part, have certain concerns about quality of materials such as cement and piping and the quality of the construction services to be provided – they have had experience with local contractors not performing in the townships to the same standard expected in more developed parts of SA.

The biggest construction issue, however, is the sewage utility – electricity and potable water are not really a problem, just a matter of building several lines to hook to the main grid. But sewage will require a very considerable infrastructure project to create – all the way from building the treatment plants and water recycling plants to main sewage lines to residential connections in a crowded urban environment. The public health benefits are enormous – but realistically it will take five years to do this whole project, at a projected cost, just for the sewage project, of US $500 million. The SA government and the housing agency Nurcha anticipate that the project will eventually pay for itself out of sewage user fees charged as a portion of the long term mortgage costs, and in fact the historical repayment rate of mortgages in Soweto has been quite good – but no one is quite sure whether the repayments on the mortgages will take place as planned and whether, therefore, the revenues to pay for the sewage project will eventually be paid. This has left questions in the minds of banks and investment funds inside and outside SA which are being asked to finance the project as to the longterm stability of the financing for the sewage infrastructure.

The total costs of the whole program, including all housing costs, utility costs, the sewage project, administrative costs, and so on, is anticipated to be US $2 billion over a 8 year period. Not all the money is needed at once, of course – draw-downs are believed to be required on average of 250 million each year, although of course the particular needs and spending issues will vary greatly from year to year.

Although ultimately all of this is to be paid for out of the mortgage payments collected from the Soweto owners over a long period of time, the multiple construction projects will have to be financed somehow by parties inside or outside SA up-front. GoodWell has acted as advisor to Nurcha and, to some extent, broker in putting together possible international financing, both for profit firms and nonprofit charities, as funding sources for the multiple projects. The two main wealthy-world parties interested in seeing the Soweto project go forward are the Anderson Foundation, a charitable foundation based in New York, and the Swatch Watch Corporation, which has sizable manufacturing facilities in many places around the world but not SA, but which is considering investment in SA.

The Anderson Foundation is willing to donate US $50 million each year for eight years provided that one for one matching funds are provided other donors. The World Bank has agreed to provide US $50 million each year for eight years as a matching grant. The EU and US AID have agreed to provide an additional US $50 million annually. However, none of these parties is willing to act alone – no one wants to contribute money to a project that doesn’t get funded sufficiently to carry it to completion – and so there is a collective action problem in which these parties are willing to act provided that each knows that the others are on board, but not otherwise.

That leaves US $100 million unfunded annually, provided that the estimates of draw-downs are correct as an approximation.

The unfunded US $100 million annually – about $800 million total over the eight years – can possibly be covered by borrowing from banks. The difficulty is that the banks want collateral or guarantees – and they want them not just for the eight years of the construction project, but for the twenty years that the money will be in the process of being repaid on the mortgages. The government of SA has offered to provide twenty year guarantees for half of that amount, US $800 million, but the banks are nervous about such guarantees.

With the worldwide banking and credit crisis, however, the issue of worry about future performance is not simply banks that extend loans worrying about getting repaid by borrowers – the borrowers who have received commitments from the banks are also concerned that the banks will make the loans down the road that they have committed themselves to make. Nurcha, your client, is particularly concerned about what kinds of contractual language might be written into the documents to protect (weirdly enough) the borrower, given the credit crunch that might extend over years, precisely when the money is most needed to complete the project.

The Swatch Watch Corporation has offered assistance of a different kind. Concerned about the ability of home owners to be able to repay their loans, it has offered to set up a local manufacturing plant near Soweto that would employ several hundred local employees and so contribute to the local economy; the hope is that if this plant is successful, it will draw other multinational manufacturers to set up in an industrial park for light manufacturing and electronics and textile assembly in Soweto. The SA government is willing to offer tax holidays for a ten year period to companies willing to come. But Swatch must make it work successfully, and it is concerned about the quality of products assembled in the proposed factory.

You are general counsel and financial advisor to GoodWell. Nurcha, in SA, has retained you to assist in putting together an overall strategy and set of transactions for the deal as a whole. You must write a memo to the CEO of Nurcha (the government-sponsored but private housing firm in SA) setting out your proposed transaction, the legal documentation for it, and particular financial or legal issues that are of particular importance and your solution to those problems. Please write that memo.


Good luck and happy holidays!

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