Employing letters of credit (L/Cs) to secure deals has become common practice in many quarters. But the experiences of the troubled US energy giant, Enron Corp, challenge some widely held assumptions that such L/Cs will make watertight a deal that one or more parties feels is unfair.

At the beginning of this year, DC World reported that Houston-based Enron had run into problems getting paid for power produced in the Indian state of Maharashtra by the Dabhol Power Company (DPC), in which Enron has a 65 per cent stake.

Double guarantee

Despite an agreement with the Maharashta State Electricity Board (MSEB) to purchase power from DPC that was backed by an L/C that in turn was double-guaranteed by both the state and federal governments, the power plant operators have throughout this year failed to obtain payment as specified in the contract.

The MSEB, backed by its state and federal guarantors and, significantly, by public opinion, maintain they cannot pay for power from DPC because it is too expensive.

Meanwhile DPC has served a preliminary notice to terminate the 1995 power purchase contract in which MSEB agreed to take 100 per cent of the power station's output. This notice says the two companies should settle their differences by November 19 or take the matter to arbitration in London.

Uncertain future

The dispute impacts not only on current DPC production from an initial 740 construction of a second 1,444 MW facility, which is 97 per cent complete. The future of DPC is now uncertain, as is the investment of over US$600 million made by Enron and its partners, General Electric Co and Bechtel.

Solutions sought

Enron has said it wants to sell its equity in DPC to the Indian government. Lenders to the controversial project - which include major banks such as Citibank and Bank of America - are to meet in London early November to see if they can revive the ailing project. They will examine several options, possibly including a bid from two Indian companies interested in purchasing Enron's stake in DPC.

Enron, its partners and investors in DPC must have thought the double-guaranteed L/C backing in their 1995 agreement was sufficient to secure payment from MSEB as per contract. Eventually, possibly after arbitration, MSEB or the project's guarantors might be forced to pay. But one thing that emerges from this particular controversy is that while L/Cs may appear to secure a deal, they may not provide solutions when things go wrong in complex project financings.

About turn

Separately and somewhat ironically it is now Enron that is being asked to secure its promises to pay with L/Cs. The US energy giant has been plagued by adverse factors over recent months. Consequently, its shares fell by as much as 60 per cent during October, it has been pressing banks for a new credit line and ratings agency Moody's has downgraded Enron's senior unsecured debt to little more than junk-bond status.

The head of risk management at one British utility company that stopped trading with Enron during October has reportedly said they were only negotiating deals secured by L/Cs with the beleaguered energy giant.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.