DBRS Confirms SNC-Lavalin Innisfree McGill Finance Inc. Series A Senior Amortizing Bonds at BBB (high), Negative

DBRS Limited (DBRS) confirmed the BBB (high) rating with a Negative trend on the Series A Senior Amortizing Bonds of SNC-Lavalin Innisfree McGill Finance Inc. (the Issuer), the financing vehicle unconditionally guaranteed by Groupe Infrastructure Santé McGill S.E.N.C. (ProjectCo) and its general partners. ProjectCo is the special-purpose vehicle responsible for the design, construction, financing and maintenance of a new 217,500-square metre hospital under a 34.3-year public-private partnership with the McGill University Health Centre (MUHC or the Hospital).

The Hospital achieved global substantial completion in November 2014, and while the service phase began at that time, certain construction works and variation directives have been disputed since then, leading to material deductions being passed down to the Service Provider as well as material accumulation of service period failure points. Since that time, however, the Independent Certifier has issued the Final Completion Certificate on November 11, 2016. The major work related to the ventilation system performed by ProjectCo was also completed in November 2016 and has reduced the deductions related to the Availability Failures resulting from the alleged incomplete works. The deductions being applied during the current reporting period relate only to a retroactive portion rather than deductions stemming from current deficiencies or failures, which is evidence of the improving performance.

At the time of the trend change to Negative in June 2016, DBRS raised concerns of the impact of several ongoing disputes and claims on the relationship between ProjectCo and the Hospital, the largest being the $330 million legal claim filed by ProjectCo against the Hospital for alleged scope changes and liquidated damages suffered by the Design-Build (DB) Contractor during the construction of the Project. The claim includes the operation and maintenance (O&M) and lifecycle costs associated to the DB claim items and other issues that has occurred during the construction phase. Since the time of DBRS’s last report, all claims were postponed, and ProjectCo pursued a mediation process with MUHC, which culminated in an agreement to resolve outstanding disputes. A proposed settlement aims to definitively resolve the action in damages of $330 million, outstanding claims by MUHC and the application for an injunction by ProjectCo for reimbursement of certain deductions.

In addition to the agreement on outstanding disputes, a number of additional structural changes have been forwarded for bondholder consent: (1) Proposed amendments to the Payment Mechanism entail notable changes in the number and classification of the hospital functional units as well as in the calculations of the related deductions and failure points. (2) Proposed amendments to the O&M Contract regarding the transfer of architectural lifecycle obligation costs and pricing risk from ProjectCo to the O&M Contractor. (3) The replacement of the parent guarantees provided by Johnson Controls Inc. relating to the project as a result of the corporate reorganization of Johnson Controls Inc., and assignment to, and assumption by, Johnson Controls Québec Ltd. of all obligations of Johnson Controls L.P. under the project documents and direct agreements. (4) Lastly, a decapitalization transaction has been proposed that will introduce subordinated debt in entities owned or controlled by SNC-Lavalin that are otherwise holding SNC-Lavalin’s interest in ProjectCo. The implementation and execution of these items requires consent of the bondholders under the Project’s Common Terms and Intercreditor Agreement.

On balance, DBRS considers these changes to be slightly positive, with the exception of the decapitalization transaction, which DBRS views as credit neutral. The end of the ongoing legal disputes, the pass-down of the architectural lifecycle obligations and the adequate resiliencies are viewed as slightly positive. While DBRS considers the resolution of the outstanding legal disputes together with a return to more modest deductions in the current reporting period as well as an amended payment mechanism that can be reasonably expected to yield reduced deductions going forward as being a concrete step to a sound contractual relationship with MUHC, DBRS does not consider this as an immediate trigger for positive rating action. As was noted in the previous year’s report, positive rating action would be considered only after a period of normalized relations between the Hospital and ProjectCo along with a prolonged period of minimal payment deduction and failure point accumulation. Negative rating action could be possible if the contractual relationship between ProjectCo and MUHC begins to show further signs of weakening. The debt service coverage ratio was 1.34 times (x) at the end of the third full year of operations, November 5, 2017, and is projected to be a minimum of 1.38x throughout the term of the service phase.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The principal methodology is Rating Public-Private Partnerships, which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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