By Alison Leckie | May 14, 2026
Course Overview
This video is the Governing Case lesson from our Advanced Project Finance Debt Modeling Online Course
In project finance, lenders assess multiple risks affecting cash flow certainty—such as revenue stability, counterparty strength, and construction risk—and apply constraints that limit debt. Each constraint produces a different debt capacity, with the lowest outcome becoming the “governing case.” This constraint drives the financing structure, though it can be negotiated if deemed overly conservative.
Video
Video Transcript
Haydn: Hey Dylan, can I borrow $100?
Dylan What are you using it for?
Haydn: Well, I’d like to try double or nothing on blackjack tonight. I’m feeling lucky.
Dylan: I’m sorry, Haydn. I’m not convinced I’ll ever see my a hundred dollars back. I can do 10 bucks. How’s that? One of the most important traits of a good lender is a knack for assessing investment risk. As lender return comes from a set interest spread on invested capital, they have little to no incentive to take on additional risk. Certainly, when compared to equity, financial risk can stem from multiple aspects of a deal. Some risks will be more obvious than others. So lenders will carefully scan projects for potential threats when they detect a likely risk. Lenders protect themselves by adding clauses to the term sheet aimed at mitigating that specific risk. As we’ll see, most of these clauses generally do one thing, restrict debt in some way.
Haydn: I see, deals with lower risk will have fewer restrictions. Right, but how do lenders think about risk
Dylan: In project finance. Term loan repayments come from project cash flows. So a lender’s view of risk is mainly tied to the certainty and timing of said cash flows, which ultimately dictates the debt quantum they’re willing to lend cashflows with higher certainty generally mean a higher debt size and vice versa.
Haydn: Makes sense. But there’s a myriad of factors that can impact the certainty of cash flows in a project. Cash flows could come from several different revenue streams be contracted or exposed to market changes. Vary by season, or by weather conditions come from a project using less established technology or even tested technology with a new core component.
Dylan: That’s the gist of the problem. Haydn. On top of this, lenders must consider if the parties involved in the project such as project sponsors, EPC contractors, O&M providers, off-takers are credit worthy and have a proven reputation. An estimation of the risk related to construction, timing costs and project specifications called completion risk, and whether they themselves have an internal lending limit, such as a maximum exposure to a certain market or borrower. These factors could make a project riskier. The lender may consider any combination of them as ingredients in their term sheet recipe, limiting debt size in the way that best suits their appetite. I mean, their… their risk appetite.
Haydn: You mentioned that these restrictions limit debt size in one way or another. How do we go about calculating the debt quantum then?
Dylan: Great question. Each debt constraint is first modeled on its own in the context of its own clauses and impacts to project cash flows, which results in a different permissible debt amount for each constraint. We then look for the constraint with the lowest permissible debt. This is the constraint that will rule them all. Since using it as a base case to structure debt will likely satisfy all other constraints. This then becomes the governing case.
Haydn: I understand that’s the safest route for the lenders, but equity could make a case about that constraint being way too restrictive in the context of their project. I imagine that could be negotiated, right?
Dylan: Indeed. If the negotiation is successful, one of the looser constraints will be agreed to be the governing case and the other ones may be used as covenants for lender protection or simply fall away if they prove redundant.
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