Lock-Up and Default: The Two DSCR Floors, and Why the Gap Between Them Is the Most Important 0.10×
A project finance credit agreement contains two debt service coverage floors, and they do entirely different things.
The lock-up level traps cash. Distributions to equity stop; the project keeps running; the lender does nothing else. The default level lets the lender accelerate the loan and, in the limit, take the project away from the sponsors.
Project credit agreements typically set the distribution lock-up DSCR roughly 0.10× to 0.15× above the event of default DSCR. On a facility sized at 1.30×, that is commonly a lock-up around 1.15× and a default around 1.05×.
That small gap is the most consequential drafting in the document, because it separates a liquidity event from a solvency event — and because a project sized at 1.30× only has to lose 11.5% of its cash flow to reach the first one.
This post covers the ladder, what the headroom actually is, what a lock-up does and does not do, the exit test that catches sponsors out, and how to price the cost of an event that never becomes a default.
ℹ️ Note: Levels vary by market, technology and offtake quality. All figures are labelled assumptions; the structure is the point.
What Is a Distribution Lock-Up?
A cash trap. When the coverage ratio falls below a stated level, distributions to shareholders are suspended and cash accumulates in the project until coverage recovers. Scheduled debt service continues; reserve accounts continue to be funded; nothing is accelerated.
Its purpose, as one description puts it, is to keep surplus cash inside the secured perimeter when coverage weakens, giving lenders time and liquidity without immediate enforcement.
That framing is worth holding onto. A lock-up is not a penalty. It is a mechanism for converting a problem that might become a solvency problem into a liquidity buffer, before anyone has to decide whether to enforce.
The Ladder
Three levels, and each is doing a different job.
| Level | Typical | What it is | What happens |
|---|---|---|---|
| Base case / sizing | 1.30× | The structuring target | Facility sized to it |
| Lock-up | ~1.15× | Distribution test | Cash trapped, no enforcement |
| Default | ~1.05× | Event of default | Acceleration, remedies, step-in |
The ordering is fixed: lock-up is always above default. A structure with them the other way round would allow the sponsor to keep taking distributions right up to the moment the lender enforces, which is the opposite of what either party wants.
The Headroom That Actually Matters
Not the DSCR. The distance from the base case to the lock-up.
CFADS fall to reach lock-up = 1 − (1.15 ÷ 1.30) = 11.54%
CFADS fall to reach default = 1 − (1.05 ÷ 1.30) = 19.23%
Band between the two = 1 − (1.05 ÷ 1.15) = 8.70%
A project sized at a comfortable 1.30× is 11.5% of cash flow away from having its distributions suspended.
Put that next to the numbers from earlier in this series. A generation-weighted basis assumption moving by two dollars a megawatt-hour. A curtailment rate moving three points. A capture rate falling five points. A single adverse operating year. Any one of those, on the worked figures from Series C, is capable of consuming most or all of that headroom on its own — and the operating leverage point from the merchant tail post applies, so each lands on CFADS harder than on revenue.
This is why publishing the DSCR is much less useful than publishing the headroom. "1.30×" sounds comfortable. "11.5% from lock-up" is a different sentence, and it is the same fact.
What a Lock-Up Does, and Does Not, Do
It does not reduce the debt. Trapped cash sits in an account. Unless the agreement provides for a sweep — which is a different mechanism, covered later in this series — the money accumulates rather than deleveraging. The project is not getting safer at any particular rate; it is just not paying its owners.
It does not accelerate anything. No default, no remedies, no step-in. Scheduled amortisation continues on its original terms.
It does hurt equity, immediately and disproportionately. Distributions are the equity return. Suspending them does not reduce the total cash the project generates over its life, but it moves it later, and equity returns are extremely sensitive to timing. The quantification is in the Excel section below and the answer is larger than most sponsors expect.
It does buy time. Which is the point. A lender facing deteriorating coverage would rather have cash inside the perimeter and a conversation than a defaulted loan and a decision about enforcement.
Getting Out Is Harder Than Getting In
This is the sharp edge, and it is where the real cost sits.
Exit from lock-up requires satisfaction of the distribution tests on the relevant test dates — often for one or two consecutive periods — together with the absence of any default and full funding of the reserve accounts.
Read that carefully. A single bad year does not produce a single year of suspended distributions. It produces the bad year, plus however many consecutive clean periods the agreement requires to demonstrate recovery, plus whatever time is needed to restore reserve balances that may have been drawn.
A one-year event under a two-consecutive-period test is therefore commonly a three-year distribution suspension. And the test is typically on a rolling twelve-month historic DSCR, which means the bad year continues to sit inside the test window for four quarters after it ends.
Two drafting points follow, and they are worth more to a sponsor than several basis points on margin.
Negotiate the number of consecutive clean periods. One is meaningfully better than two, and the difference is a full year of distributions.
Negotiate the reserve restoration condition. A requirement that all reserves be fully funded before distributions resume can extend a lock-up well beyond the point at which coverage has recovered, particularly where a maintenance reserve was drawn.
What Happens to the Trapped Cash?
It stays inside the secured perimeter, and what happens next is genuinely negotiable.
The default position is that surplus cash accumulates in a project account — the proceeds account, or a dedicated distribution reserve — continues to earn interest for the project, and is released to equity when the exit conditions are satisfied. Nothing is applied to the debt.
Three variants appear, and the difference between them is worth real money.
Full release on exit. The sponsor gets everything back once coverage recovers. This is the sponsor-friendly version and is common where the lock-up level is set conservatively.
Partial sweep. A stated share of trapped cash — often 50% — is applied to prepay debt rather than being released. The lender gets permanent deleveraging out of a temporary event, which is a substantially better outcome for it and a permanently worse one for equity.
Full sweep. Trapped cash is applied to the debt entirely. Economically this converts the lock-up into a cash sweep, and at that point the two mechanisms are the same clause.
The distinction matters because the cost of a lock-up is completely different under each. Under full release it is a timing cost — the 4.2% NPV effect computed below. Under a full sweep the cash never comes back at all; equity has funded a prepayment out of a bad year, and the loss is the full amount rather than its deferral.
A sponsor reading a term sheet that mentions a lock-up should therefore establish, before anything else, whether the trapped cash is released or applied. Two clauses that read almost identically produce outcomes an order of magnitude apart.
What Else Triggers It?
DSCR is the headline test and rarely the only one.
Distribution conditions in a typical agreement require, cumulatively: the coverage test met on the relevant date; no default or event of default subsisting; all reserve accounts fully funded to their required levels; and often a forward-looking test as well as a historic one.
Each of those is a separate way to lose distributions, and two deserve specific attention.
The forward-looking condition is the softest and the most contested. A requirement that projected DSCR for the next twelve months also clears the threshold hands the lender a veto based on a forecast — and the drafting question is whose forecast, updated when, and on what assumptions. Series C's material is directly relevant: a lender revising its curtailment or basis assumption can trigger a forward-looking distribution block on a project whose historic performance is fine.
"No default subsisting" sweeps in everything else in the agreement. A reporting failure, a lapsed insurance policy, an unremedied permit condition — none of which has anything to do with coverage — can block a distribution just as effectively as a covenant breach. In practice these are the most common causes of a delayed distribution, and they are administrative rather than financial.
The practical instruction is to treat the distribution conditions as a checklist maintained continuously, not as a ratio tested twice a year. Most missed distributions are not coverage events.
What Else Does the Test Gate?
More than distributions, and the additional items are easy to overlook.
The same or a similar test typically governs all restricted payments, which can include subordinated or shareholder loan service, management and development fees payable to the sponsor, and any payment to a related party outside the ordinary course. A sponsor that has structured part of its return as a management fee rather than a distribution may find both blocked by the same clause.
The test also commonly gates additional indebtedness — though as the previous post argued, that is more naturally an LLCR question than a DSCR one, since it is a solvency rather than a liquidity test.
For a sponsor this has a structuring consequence worth planning for. Returns routed through a subordinated loan are sometimes assumed to be more robust than dividends because they are contractual obligations rather than discretionary payments. Where the restricted payments definition captures them — and it usually does — that assumption is wrong, and the two routes are equally exposed to the same lock-up.
Equity Cures
Some facilities permit an equity cure: the sponsor injects cash, the injection is treated as CFADS or as a reduction of debt service, and the ratio is restored.
Where available, the terms are where the value is.
How the injection counts. Treating it as CFADS raises the numerator and cures the current period. Treating it as a prepayment reduces future debt service and helps subsequent periods. The two are not equivalent and sponsors should know which they have.
How often it can be used. Cures are typically limited — a stated number of times over the life of the facility, and often no more than twice consecutively. A limit is reasonable; an unlimited cure would make the covenant meaningless, since a solvent sponsor could pay its way past any ratio.
Whether it cures lock-up, default, or both. These are frequently different. A cure right that restores distributions is valuable; a cure right that prevents acceleration is worth considerably more.
The honest observation about equity cures is that they are most useful for timing mismatches and least useful for structural deterioration. A project that needs a cure once, after a storm year, is using the mechanism as intended. A project that needs one every year has a different problem, and the cure limit is what forces that to be acknowledged.
Where Does the DSRA Fit?
Between the two floors, functionally.
The debt service reserve account holds cash — typically six or twelve months of debt service — available to meet payments if operating cash flow falls short. Its job is to stop a shortfall becoming a payment default.
The sequence in a deteriorating project is usually: coverage weakens, the lock-up triggers and distributions stop, coverage weakens further, the DSRA is drawn to meet debt service, and only then does the question of default arise. Where the DSRA is depleted, the options narrow to equity injection, continued distribution suspension, or renegotiation.
Two points worth noting. The DSRA should not normally be included in the DSCR calculation itself, because a ratio that passes because a reserve was drawn is measuring the wrong thing. And a drawn DSRA usually has to be restored before distributions resume, which is the reserve restoration condition described above — so the reserve and the lock-up are linked mechanisms, not independent ones.
How Do You Model This in Excel?
As headroom percentages and an explicit event scenario, not as a pass/fail flag.
The headroom, which is the reporting output
Base_DSCR 1.30×
Lockup_DSCR 1.15×
Default_DSCR 1.05×
Headroom_to_lockup = 1 − Lockup ÷ Base = 11.54%
Headroom_to_default = 1 − Default ÷ Base = 19.23%
Band = 1 − Default ÷ Lockup = 8.70%
Publish the first of those on the front page of any credit paper. It converts a ratio into a statement about how much can go wrong.
The cost of a lock-up event
Assumptions, labelled as such:
Annual distribution $8,000,000
Project life 20 years
Equity discount rate 12%
Event year 5, one bad year
Exit test 2 consecutive clean periods
Suspension years 5, 6 and 7
Release lump sum in year 8
NPV of distributions, no event = $59,755,549
NPV of distributions, with the lock-up = $57,237,489
-----------
Cost of the event = $2,518,060 (4.21%)
A single bad year, fully recovered, with every dollar eventually paid, costs equity 4.2% of the present value of its entire distribution stream. Nothing was lost — the cash was deferred by three years and released in full. Timing alone did that.
The sensitivity that makes the drafting point
Exit test = 1 consecutive period → suspension of 2 years
Exit test = 2 consecutive periods → suspension of 3 years
Exit test = 3 consecutive periods → suspension of 4 years
Each additional consecutive period required is roughly another year of deferred distributions. That is what the drafting negotiation is worth in cash, and it is almost never quantified before the agreement is signed.
The sweep variant, which changes the answer entirely
Full release on exit NPV cost = $2,518,060 (4.21%)
50% swept to debt cash permanently lost = $12,000,000
NPV cost = $7,364,659 (12.32%)
The second line is not a refinement of the first; it is a different transaction. Under a sweep the sponsor has prepaid debt out of a bad year using money it will never see again, and the equity cost is roughly three times larger. A model that reports a lock-up without establishing which variant applies has produced a number with an error bar of an order of magnitude.
The event to actually test
Run: the single worst plausible operating year, at the lock-up threshold
Report: trigger? yes/no · years of suspension · NPV cost to equity
ℹ️ Note: Model the lock-up as a cash flow consequence, not a covenant flag. A model that reports "lock-up: TRUE" and continues distributing has not modelled it at all — and that is a surprisingly common defect, because the covenant tests and the distribution waterfall are often built in different parts of the workbook by different people.
To build the headroom analysis and the lock-up event cost, prompt Dezzmond with your ratio levels and distribution profile.
What Do Sponsors and Lenders Actually Check?
- What is the headroom to lock-up as a percentage of CFADS, not as a ratio?
- How many consecutive clean periods are required to exit, and has that been priced?
- Must reserves be fully restored before distributions resume?
- Is the lock-up modelled as a cash flow consequence or only as a flag?
- Is there an equity cure, how does it count, and how often can it be used?
- Is the gap between lock-up and default 0.10× to 0.15×, or unusually wide or narrow?
- Is the test rolling twelve-month historic? If so, a bad year sits in the window for four quarters after it ends.
Frequently Asked Questions
What is a DSCR lock-up?
A distribution test. When coverage falls below the lock-up level, distributions to equity are suspended and cash is trapped in the project until coverage recovers. Debt service continues and nothing is accelerated.
How far apart are the lock-up and default levels?
Typically 0.10× to 0.15×, with lock-up always the higher of the two. On a facility sized at 1.30×, a common structure is lock-up at 1.15× and default at 1.05×.
How much can cash flow fall before a lock-up triggers?
On those levels, 11.5%. A further 8.7% fall from the lock-up level reaches default. Those percentages are a more useful statement of headroom than the ratio itself.
How long does a lock-up last?
Longer than the event that caused it. Exit typically requires passing the distribution test for one or two consecutive periods with no default and reserves fully funded, so a single bad year commonly produces a three-year suspension.
Is trapped cash returned to the sponsor?
It depends entirely on the drafting. Full release on exit makes a lock-up a timing cost; a partial or full sweep applies the cash to the debt permanently, so it never comes back. Two clauses that read similarly produce outcomes an order of magnitude apart.
Can something other than DSCR block a distribution?
Yes, and usually does. Distribution conditions typically also require no subsisting default, all reserves fully funded, and often a forward-looking coverage test. Most missed distributions are administrative — a reporting failure or lapsed insurance — rather than coverage events.
What does a lock-up cost equity?
On the worked example, a single fully-recovered bad year costs 4.2% of the present value of the whole distribution stream — with no cash lost at all, purely from a three-year deferral.
Closing: Negotiate the Clause You Will Actually Hit
Sponsors spend most of their covenant negotiation on the default level, which is reasonable in that a default is the catastrophic outcome. It is also the level they are least likely to reach, because the lock-up sits above it and does its job.
The lock-up is the clause that actually binds. It triggers on an 11.5% fall in cash flow — well inside the range of a single adverse assumption from any of the preceding series. It costs equity four percent of its entire distribution NPV for one recovered bad year. And the terms that determine how long it lasts, the number of consecutive clean periods and the reserve restoration condition, are usually agreed quickly because they read as machinery rather than as economics.
They are economics. Each additional consecutive period required is about a year of deferred distributions, which on the worked figures is worth more than several basis points of margin over the life of the facility. And the question of whether trapped cash is released or swept moves the cost of the same event by a factor of three — $2.5m against $7.4m on identical facts, decided by a clause most term sheets dispose of in a line.
There is a reason this asymmetry persists, and it is worth naming. Margin is quoted, compared across term sheets, and reported to investment committees. Lock-up mechanics are not quoted, are hard to compare because they are drafted differently in every agreement, and are usually reviewed by lawyers rather than by the people who built the model. So the term that is easy to benchmark gets negotiated hard, and the term that is worth more gets accepted as market.
The general instruction is the one this whole series keeps arriving at: report headroom rather than ratios, model consequences rather than flags, and quantify the clauses before agreeing them rather than after triggering them.
The next post follows the cash itself, through the waterfall that decides which of these mechanisms gets paid first.
Sources: LexisNexis — Project Finance Financial Covenants · Stonewake — Distribution Lock-Up in Project Finance · Forvis Mazars — What Is the Debt Service Coverage Ratio in Project Finance? · Numeritas — PF Basics Part 3: An Overview of the DSCR