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

DBRS Limited (DBRS) has today 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).

In June 2016, DBRS placed the BBB (high) rating on a Negative trend due to a number of issues related to (1) a legal claim for $330 million lodged by ProjectCo to the Hospital, (2) a formal demand letter and an injunction from ProjectCo to the Hospital concerning deductions and failure point relief for alleged deficiencies and unfinished work and (3) the issuance of warning notices to ProjectCo as a result of failure point accumulation. Stage 1 and Stage 2 Substantial Completion were achieved on September 30, 2014, and November 5, 2014, respectively, and the Project is almost two years into the 30-year operations phase.

DBRS previously noted the $330 million legal claim filed by ProjectCo against the Hospital for alleged scope changes and liquidated damages suffered by the Design-Build Contractor during the construction of the Project. The hearing is not anticipated to take place until 2018. As it previously noted, DBRS remains concerned that the size of the claim and the inability to achieve a settlement short of litigation may potentially cause lasting impacts on the relationship between ProjectCo and the Hospital.

In May 2016, DBRS noted that ProjectCo issued a formal demand letter in response to deductions that have been levied by the Hospital against the periodic service payments paid to ProjectCo for alleged deficiencies and unfinished work. While ProjectCo is of the view that the deductions relate to works undertaken as variation directives to the Project Agreement (PA), the Hospital has rejected ProjectCo’s claims and contends the work performed to be part of the original project scope. The cost to complete the work pertaining to the disputed items is estimated to be roughly $5.0 million and primarily relates to ventilation matters. To date, MUHC has acknowledged that progress has been made in completing the remaining work and ProjectCo has indicated that Final Completion is expected to be achieved by the end of 2016. Unavailability deductions relating to the works in question continue to be levied by the Hospital and amount to roughly $2 million per month, or approximately $20 million cumulatively to date, and continue to be fully passed down to the O&M Contractor, SNC-Lavalin O&M Inc., while having no effect on principal and interest payments.

In the same month the demand letter was issued, ProjectCo filed an application for a safeguard order, as part of an injunction procedure, to direct the Hospital to suspend deductions arising from works that are under dispute and to place the deductions in a trust account until the matter is resolved pursuant to the dispute resolution process under the Project Agreement. While the hearing for the safeguard order was held at the end of August 2016, the decision is still pending. Additionally, the injunction will direct MUHC to follow the dispute resolution process pursuant to the Project Agreement. As stated in DBRS’s previous press release in June 2016, the rights and security interest of the bondholders are not affected in this case, as the deductions are wholly passed down to the O&M Contractor and debt service payments have not been affected.

In June 2016, DBRS learned that ProjectCo received three warning notices related to service-related deficiencies in IT, telecom and facility maintenance, dating back to the spring of 2015, which were due to temporary circumstantial issues such as patient transfers and minor construction works. Pursuant to the PA, enough failure points had been accumulated to allow the Hospital to compel ProjectCo to replace the O&M Contractor; however, since that time, the rate of accumulation of failure points has returned to more moderate levels of less than half of the threshold for O&M contractor replacement. Discussions are ongoing to reverse the failure points that resulted from alleged service-related deficiencies and no additional Warning Notices have been received by ProjectCo. While there has been further communication between ProjectCo and the Hospital disputing the calculation of failure points pursuant to the payment mechanism, the Hospital has continued to indicate that there is no intention to seek replacement of the O&M Contractor.

Negative rating action would be likely should the judicial processes or dispute resolution procedures carry on for a protracted period, or if MUHC compels the replacement of the O&M Contractor. Positive rating action could result from the timely resolution of outstanding lawsuits and disputes, the normalization of relations between the Hospital and ProjectCo and a prolonged period of minimal payment deduction and failure point accumulation. The debt service coverage ratio (DSCR) was 1.36 times (x) at the end of the first full year of operations, November 5, 2015, 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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Public-Private Partnerships (March 2016), which can be found on our website under Methodologies.