Option to qualify for CAP project funding — Avalized Promissory Note

Project developers can qualify for project funding under In3’s Completion Assurance Program™ (CAP) using a simple, 1-page commercial Promissory Note (PN) per bank “aval” as an alternative to a Standby Letter of Credit (SbLC), cash surety deposit, Securities, or Sovereign Guarantee (SG).  These are presently the main Security options available to obtain project financing through In3’s Family Office partners.

For a shorter overview of AvPNs and how they work, go here.  What follows are more complete details for financial practitioners.

In brief …

An Avalized Promissory Note (AvPN) is similar in most respects to the SbLC mentioned above; it is governed by the same banking rules, for example.  Main difference:  while a SbLC comes from an issuing bank, the AvPN is company-issued then stamped or endorsed (Avalized) by a rated bank, which if properly understood solves several challenges with SbLCs, such as the need to hypothecate collateral to another bank to issue the SbLC.  Because AvPNs are issued by a private party, not a bank — the bank’s role is limited to the aval — the asset holdings of that private party or balance sheet may be sufficient to obtain the bank’s Aval, and thus would not require transfer of collateral to a different banking institution so they could issue a Standby LC (SbLC) instead.  Of course, the private company could ask their bank to issue this SbLC instead, as they are more widely used and understood than bank Avals in the US and certain other markets.

Indeed, for creditworthy PN issuers, the AvPN reduces or eliminates bank fees and the need for a pledge or hypothecation of specific collateral to the bank.  Types of assets

AvPNs also avoid transmittal by SWIFT (hardcopy can be sent via courier), though by itself, that (avoiding the SWIFT fee, for example) probably isn’t sufficient reason to switch from SbLC to AvPN.  This point may deserve discussion.  The real question is what can the involved banker agree to.  If the answer is “neither” AvPN nor SbLC (nor BG, PG, SG), you can either find a different banker, different bank, or pivot to Cash Surety Deposit.

Why this matters?

Sovereign Guarantees (SGs) have become less common (only a few countries still issue them, in the years following the Covid pandemic), and we hear reports from clients that SbLCs are sometimes impractical, or out of reach, such as when the bank expects unreasonable collateral (cash on deposit) or initiation fees, which usually happens when they confuse a Standby LC with a Documentary LC commonly used for trade finance transactions (more on this), or due to other misunderstandings, such as the fact that “cash backed” instruments do not necessarily require cash in hand — whatever assets the bank will accept, typically  underperforming or “distressed” assets, such as office buildings, semi-liquid, or entirely illiquid assets, if available with proper ratings, are often usable.  We do not need to know what assets are used with the involved bank to generate the required Security — all are fine with us.

When seeking 100% financing, CAP funding still brings sharp advantages not available without a guarantee of some sort, even if it leveraged (that is, the total funding is greater than the face value of the guarantee), so this AvPN instrument may be the answer, especially if you have been bumping into the aforementioned limitations.

Strategy check:  if you have not already asked your bank or a potential sponsor (such as a well-established EPC firm or General Contractor, hired to build the project) about the more conventional SbLC approach, we strongly recommend that you do that first.  Ask your bank, or have a sponsor ask theirs, if they can provide the qualifying SbLC using our recommended verbiage, or something similar (in their own format).  Templates available here in downloadable MS Word. Proceed in the sequence provided — first the PN wording itself, as a proposal for our acceptance, then the Bank’s Verification Letter, followed by the ATV letter.

For a synopsis of the advantages and differences between this AvPN approach and the more common Bank Guarantee/Standby LC pathway, review this comparison.

The rest of this article provides a deeper dive into the terminology, mechanics, and rules governing our request for an Avalized Promissory Note to reliably secure project funding.

Definitions — terminology demystified 

• Commercial Promissory Notes are highly versatile legal/financial instruments, normally used for private debt obligations, but used here per the conditions of well-established Uniform Rules of Demand Guarantees (URDG ICC 758) with advantages over BG/SG of simplicity and a neutral or positive market reputation.  Promissory notes fit somewhere between “the informality of an IOU and the rigidity of a loan contract.” source
• What’s a Bank Aval? It is effectively a bank’s stamp or seal that is added to a debt obligation as the avalizing party’s endorsement of the issuer’s legitimacy and capacity to issue the instrument, which is, in this case, a Commercial Promissory Note (PN).  In the context of project finance, used in this way (as completion assurance or Security), PNs serve as a contingent debt obligation that the bank’s customer issues to a third party (the Beneficiary, In3 Capital Partners, in this case) to satisfy the requirements of our funding partner’s bank per a funding agreement with the Beneficiary.  The purpose remains the same as with other security, such as bank’s guarantee or Standby LC (SbLC, to which it is most similar):  in order to ensure that projects get completed.  Some PNs are direct debt obligations (effectively a loan); this PN, however, is a contingent obligation, not directly equivalent to loans.  There is no debt to pay or repay; we’re using this structure as a service that assures project completion, then the AvPN is allowed to expire.
• What banks will provide an Aval? Bank Avals are more widely used in Europe and Asia than the US, so best to work with banks that operate outside the US.
• What does an Aval mean to the bank?  For project finance transactions, when a bank adds an Aval, it may initially assume (incorrectly) that it is acting as a cosigner with the company, taking on their contingent obligation as co-guarantor.  That would be more the case with a Trade Finance Aval where there’s a seller and buyer, and the AvPN (or Documentary LC or Standby LC) effectively pays the seller at the completion of the transaction.  In this case, however, with URDG 758 as the specified legal venue, the AvPN is released once the project reaches commercial operation date (COD), not cashed.  There is no trade transaction, no buyer, no seller, no loan … so the bank is not playing a role similar to trade finance cosigners [source]. Thus, ask bank officers about this, because if they presume the commercial Promissory Note (PN) is for trade finance, they are unlikely to agree to an Aval without cash on deposit no matter how creditworthy their customer.  There are exceptions here, but if they are saying “no” and you have presented the availability of collateral (other than cash on deposit), this could be the root of the problem — their misunderstanding about the nature of this project finance undertaking. Point out, that in this case, the PN is actually being used for Project Finance completion surety, not trade, not as a loan, etc.  The AvPN “per Aval” stamp puts the bank in a secondary guarantor position; that is, if (and only if) the PN issuer defaults due to bankruptcy, or fraud, or other insolvency, would the bank be “on the hook” in the extremely unlikely event that the project company fails to keep its promise during construction. In practice, we would fine some other way to cure such a contractual breach, but they may still feel “insecure” if they presume (through lack of balance sheet depth or other collateral assets sitting in the issuer’s bank account / holdings). Some bankers can’t wrap their head around this distinction at first because they are so familiar with commodity trade transactions, with their underlying Documentary LCs, Standby LCs, traditional PNs, or other forms of trade finance guarantees.  It may be hard for them to “unlearn” that more familiar experience so they can let in how this AvPN is different, and how the release of the PN’s value upon maturity means they’re not cosigning for the money.  The funding is for another purpose (the project) and that means their Aval (the bank’s stamp on the PN) states 1) That the issuer of the PN is a valid corporation, in good standing, and 2) The bank’s role is backup to the issuer’s contingent obligation to finish the project.  If the PN issuer doesn’t happen to be a creditworthy party in good standing, and/or with some form of collateral, the Aval will not help because, in order to minimize the bank’s potential loss in the event of the PN issuer’s default (even if there’s a very remote chance of that happening), the bank would likely assume they require cash on deposit or something similar to offset their exposure as secondary guarantor.  An Aval is effectively a stamp or certification that says “We know who these people are and we will vouch for their legitimacy and creditworthiness,” so any less-than-creditworthy company issuing a PN is not going to stand on their own in the eyes of the bankers.  In this way, the bank’s Aval provides a backstop for the PN, issued by the company, but doesn’t solve the common challenge of asset depth for some form of Security, used to gain bankability for a transaction — CAP financing one or more projects.
• Important for bankers to understand that the company issuing the PN (whether the project’s developer or a “sponsor” such as the selected General Contract, an EPC firm, or IGF syndicate) will also be the recipient of the associated project funding, so assuming these parties are non-fraudulent, those assets will be built and jointly owned by the investor to back the PN during construction.  The instrument’s callable value under URDG 758 is limited to the amount of funding transferred against it.  This means that the initial exposure to the issuer and the bank providing an Aval is nill.  Nothing.  There is zero callable value, so the instrument does not provide any exposure whatsoever. With monthly draws of capital going into tangible assets being built, there’s inherent economic value in the overall undertaking, with business logic (as defined and governed by the project’s Loan Agreement) to prevent any frivolous actions by In3 and its partners (the Beneficiary of the AvPN).  This is why an AvPN arrangement tends to work out well for all parties:  like a BG/SbLC, an AvPN cannot be called arbitrarily, and so it may be necessary to demonstrate to the involved parties that there’s no way they can lose (if they’re non-fraudulent and do their respective jobs), usually a source of comfort and confidence in the entire undertaking.
• What does it mean for a bank to “avalize” a document? 
  • Unlike a BG/SbLC, a Commercial Promissory Note with a bank’s aval comes from a company, not from a bank, where the bank’s fiduciary responsibility is probably more limited.  A basic acknowledgement that the issuer is qualified and creditworthy enough to provide the PN for the project, but if the PN issuer is not well established and financial healthy, the bankers may instead answer that the aval means they the bank is playing a “cosigner” role for the PN and thus requires collateral.
  • Like BG/SbLCs, the AvPN stands on its own, and does not necessarily reference the commercial agreements (Loan Agreement or Share Purchase Agreement with our capital partners, or any agreement with a sponsor), though it can and often does reflect and refer to such agreement(s).  It conforms with well-proven URDG (ICC pub. no. 758, 2010 edition), where the AvPN hardcopy is sent (no SWIFT needed) to reach financial closing, and is identical to a BG/SbLC in most other respects.
  • In all of these cases, the ability to avalize a PN comes in handy for additional security and to align incentives between the developer and any sponsoring company issuing the PN. This is particularly the case when dealing with large sums of money (also the reason BGs and SGs have attracted fraudulent scam artists) that multiple stakeholders must rely on, typical of all mid-market project finance, providing an “external bridge of support” that can “bolster the deal” [source].

What remains the same, what’s different with an AvPN versus a Bank’s Guarantee?

An Avalized Promissory Note (AvPN) still serves as a way to secure financing, and as completion surety, for projects financed through In3’s Family Office partners, issued with a maturity date or expiration date of one year or more, with many similarities to a BG/SbLC, and largely the same terms and conditions.  Then what’s the real difference or advantage over the BG/SbLC?  Three:

1. Gaining a bank’s cooperation may be easier than with a BG/SbLC because their role as guarantor is secondary to the PN issuer’s.  If the issuer of the PN (a private company) is creditworthy in the eyes of the bank, then the bank’s Aval will confirm that the issuer is unlikely to default, is in good standing with the bank, and thus presents very limited exposure to the bank.  If they perceive any real risk of default on the PN’s contingent obligation, they will either decline to provide the aval, or ask for collateral of some sort.
2. The Aval will likely cost less (or cost nothing) compared to a bank’s issuance of a BG/SbLC, and
3. An AvPN has none of the baggage or confusion associated with BG/SbLCs, which some bankers confuse with a trade-related Documentary Letter of Credit, or distrust due to numerous ongoing scams with BG/SbLCs. 

This comparison chart draws out these distinctions (click to enlarge):

Both AvPNs and BG/SbLC’s follow the same rules of ICC URDG 758, which ensure that either instrument cannot not be misused or “called” arbitrarily. 

In fact, neither instrument can be called (a claim made against it) except as an absolute last resort, following a lengthy cure period, to avoid breach of contract.  The governing contract is a Loan Agreement put in place with the funding partners that spells out the terms and obligations of the parties (see FAQ for details). Such breach really must not happen, as it would be a strong negative reflection on all parties, and constitutes deliberate fraud on behalf of the developer.  URDG ensures that all non-fraudulent parties are protected.

How does it work?

Download and use three templates for an AvPN in the sequence shown in this Dropbox folder.

In essence, 1) First a draft of the PN based on our template can be crafted and approved by us.  Assuming no material changes are made to the PN’s verbiage, then 2) A bank’s letter of intent (LOI) would be signed and sent from the bank that will later provide the aval on the issuing company’s PN.  This is initially just the bank’s LOI, ahead of providing the Aval, so when the time comes (once the project is under contract, as the last step before financial closing), the bank reliably adds their stamp and confirms (takes responsibility for) the AvPN via SWIFT notice.  Final step is 3) The issuer provides an Authorization to Verify (ATV) letter that enables us to verify the transaction via direct Email, which is what launces our formal due diligence.

The LOI does not constitute a commitment. There are multiple contingencies — things that could go wrong before the AvPN is actually issued and then stamped.  This LOI sets the stage, and describes future actions that are all contingent upon key contracts being first put in place and accepted by the various parties, which along with the project’s information basics serves to launch In3’s underwriting, where due diligence is quite rapid and streamlined compared to traditional project finance.

These actions are almost exactly the same procedure and terms as with a Bank Guarantee/SbLC, but this new option for accessing CAP funding, will likely be easier for companies with decent credit ratings and/or assets in reach.  Easier still, our Cash Surety Deposit — not a down payment (capital contribution) at all, as the cash funds, held in a custodial account during project construction, are returned upon the final drawdown.  Note that AvPNs are less widely used, while cash has become our most popular form of Security for CAP’s “no money down” 100% funding.

Status & Testimonials

Our partner’s main banks have agreed to accept this Commercial Promissory/Aval and there have been some early success stories with clients that have used it to qualify.  Your results will be logged to expand our knowledge base as we complete transactions together.  There is not yet a ready-made database of testimonials that we can use to promote the virtues of this approach because it is fairly innovative to apply a Promissory Note with separate (bank) Aval to project finance security and completion surety.  We will continue building out this ecosystem in 2025.  Thus, we wish to hear from you so we can learn this together and “benchmark” challenges as well as completed transactions.  Thanks in advance for your leadership, diligent efforts and reports on how APNs have worked for you in practice to unlock expedited CAP project funding at advantageous rates, faster, and with greater flexibility in getting through Due Diligence without show-stopping issues.

Conclusion:  Top three situations where an AvPN would make sense:

1. When the issuing bank personnel cannot offer reasonable terms for the more common Standby Letter of Credit (SbLC), Bank Guarantee (BG), or a Sovereign Guarantee is available but the issuer cannot gain validation of the issuer’s authenticity:  Bankers involved in trade finance often have extensive experience with “Documentary” letters of credit, but are less familiar with Standby LCs used for project finance.  Our SG verification letter to route it via SWIFT MT760 is also quite innovative.  This is because our Family Office’s SbLC, AvPN and SG approaches resemble the use of these instruments in different contexts, and can thus be confusingly similar to how we work.  Some bankers simply cannot wrap their head(s) around how URDG ICC 758 makes the undertaking reasonably safe, or just don’t know enough to judge the potential risks with open eyes.  So they can get stuck in “analysis paralysis” and confusion, afraid of making a mistake and unable to produce acceptable instrument language for their customer.  Of course, after a few tries, depending on the level of skill and experience, frustration can set in.  If you are experiencing this, perhaps it is time to switch to an AvPN instead?  An AvPN cannot be confused with a trade-related SbLC, avoids the fraud and bank guarantee “baggage” that has become so widespread, also avoids the perception that the instrument can be called arbitrarily, or used fraudulently, along with a host of other common misunderstandings.  (More about the myth of cash collateral and other potential misunderstandings when communicating with bankers:  this article is meant to assist project developers and sponsors to avoid walking on eggshells with white-knuckled bankers.)
2. Developer has no unexpended cash, assets, or credit, but they can access assets or approach a sponsor that can hypothecate assets they own (or have balance sheet depth in the eyes of their bank):  Usually when the developer has limited financial depth (quite common with new project developers or those who are entering new markets, so no shame in that) the best plan is to involve a sponsoring EPC firm, General Contractor or major vendor as the source of a partial SbLC.  Alternatively, you can consider hiring In3 and involving our strategic initiative, the Impact Guarantee Fund (IGF), a “Done For You” solution.  Multiple concurrent sponsors are not uncommon (use one party’s commitment to gain another, or at least negotiate on that basis).  When the developer has insufficient wherewithal to pay any bank fees to obtain an SbLC / Bank Guarantee, an AvPN may cost less and/or not require underlying cash collateral, as mentioned above, so may provide a way to avoid involving a sponsor altogether. Ask an issuing bank — whether your own or the sponsor’s bank — for a preliminary cost estimate.  
3. Lower overall cost-of-capital: Some projects are quite sensitive to fees or other costs of securing the capital. Because it is company-issued, not from a bank, AvPNs may have the advantage of lower fees than BG/SbLCs, if the company has established credit worthiness.  Of course, a credit-worthy customer may not be charged much for a BG/SbLC either, so either way, certain, well-qualified companies and their sponsors will benefit, but more substantially with an APNs as it uses the issuing company’s credit rating and standing with the bank, with a greater probability of requiring no underlying collateral.  Ask your bank.  Actual fees, if any, are on a bank-by-bank basis.

Third Party Reference

Excerpts from online articles (edited to apply here):

• From https://www.investopedia.com/terms/a/avalize.asp:  “An Aval is a formal assurance or guarantee that a third party adds to a debt obligation or a contractual document,” where “… a third party avals the document, stating that all the debt obligations will be carried out by the individual.”  Note that this “debt obligation” is more typical of a loan guarantee (for the life of the loan), which our completion guarantee does not require.
• From https://www.investopedia.com/terms/a/aval.asp:  An avail “entails the third party writing the words ‘by aval’ [our templates uses ‘PER BANK AVAL’] on the physical contract document.”
• From TheBusinessProfessor.com/avalize-explained:  “When banks or credit institutions avalize customers, certain qualities must be seen in the buyer. No third party, whether bank or credit institution will aval an insolvent buyer or customer, … only solvent and lucrative customers can be avalized in order to reduce risks.
  A third party only agrees to avalize a solvent and profitable [developer/sponsor’s] contractual terms [the Commercial Promissory Note, in this case, which ties to the funding via a Loan Agreement and Share Purchase Agreement, described next].  “When companies or business owners apply for debt instruments, it is often to provide capital and financing or their business, [but] before a debt can be issued, there are terms of contracts that the buyer must agree to live by.”
  When a third party, bank or credit institution guarantees that a buyer will carry out all debt obligations in the terms of contract, any default on this makes the guarantor or cosigner liable. These terms include principal, interest rate, liabilities, maturity date, issue date and others.”