Definition of Deficiency Agreement
A deficiency agreement is an arrangement in which a party provides a firm with funds to cover any shortfalls arising from capital or cash flow restraints, allowing the company to service its debt. A deficiency agreement will usually have a cumulative limit specified by the lending party.
It is not uncommon to see this expression called a cash deficiency agreement. For project finance sponsors, a deficiency agreement makes up for any shortfall caused by insufficient working capital or cash inflows. In these instances, they may also be referred to as a make up arrangement.
Breaking Down Deficiency Agreement
Deficiency agreements allow firms to avoid the possibility of default during difficult periods. These types of agreements will usually involve parties that have an interest in the company and want to see it continue operations.
While a deficiency agreement will cover an entire company, it may be specified to protect a smaller aspect of the business. For example, a new project may have unstable cash flows and be unable to generate revenues until it reaches a certain level of operations. To prevent the project from failing, a deficiency agreement could provide it with enough cash until a revenue stream is established.
In project finance, especially construction, a cash deficiency agreement includes one party providing for the other up to a certain amount, so that the second party may temporarily alleviate its cash flow problems until profitability is restored. This especially applies to a situation in which one or more of a second party's products are not selling as well as anticipated. This agreement allows the borrower to service its debt without risking default.
Within the oil and gas industry, throughput contracts can often include throughput and deficiency agreement component to facilitate indirect financing alternatives.