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ACREL Papers
Winter 2013

Introduction

During the past several years the business world has developed an increased awareness of and commitment to sustainability. Over the last five years, worldwide companies increased sustainability reports.1 In North America there was a 27% increase between 2010 and 2011, and 95% of the 250 largest companies worldwide now report their sustainability performance.2

The interest in sustainability is particularly evident in the sector of solar development. The development of solar generation facilities in 2010 doubled over that in 2009, and the installed capacity in 2010 was more than eight times that of 2006.3 Wal-Mart, Costco and Kohl’s Department Stores are the top three U.S. retailers employing solar facilities in their leaseholds.4 The top 20 companies in the United States are generating an estimated $47.3 million worth of electricity annually using photovoltaic solar installations. Wal-Mart’s goal is to become powered 100% by renewable energy.5 Ikea has almost completed implementation of its plan to invest $723 million in renewable energy at its stores.6 Seventy-nine percent of its stores in the United States have solar installations.8 Public universities are advancing sustainability as well. Recently, Rutgers University installed an7 megawatt carport at one of its campuses, covering 32 acres.8

Much of the drive behind the increase in solar development in the United States is a by-product of a perfect storm – high electric energy costs, initiatives at the state and federal levels promoting renewable energy, including use of brownfields and landfills for solar development, and a recognition in the real estate community that there is income to be harvested from the development of solar fields on rooftops, parking lots and unused land.9

This article provides a general overview of some of the state and federal initiatives that have coalesced to spur solar development, examines due diligence issues that should be examined in connection with a solar development project, examines issues that need to be evaluated with respect to the most common project documents used in connection with a solar development project, including engineering, procurement and construction agreements, solar site leases, power purchase agreements, and operation and maintenance agreements, and examines the relationship between the project lender and mortgage lender and the typical agreements entered into to address the relative interests of each. The article focuses on net metered projects, rather than grid connected projects.10 This article is written primarily from the perspective of the property owner/landlord.

 State Legislation and Incentives11

Twenty-nine states and Washington D.C. have renewable portfolio standard (“RPS”) legislation for multiple forms of alternative energy, including solar.12 An example of such legislation is the New Jersey structure. New Jersey is second behind California for the number of solar installations.  The growth of the New Jersey solar market is largely attributable to the State’s enactment of an RPS that, in part, requires a minimum solar component. The solar RPS requires a set percentage (depending on the energy year in question) of kilowatt hours of electricity sold in the State by each electric power supplier and each basic generation service provider to be from solar electric power generators connected to the distribution system in the State.13 The legislation requires the percentage of solar power included in the electric power portfolios of New Jersey suppliers and providers to increase incrementally from 2.050% in energy year 201414 to 4.100% in energy year 2028. If a supplier or provider fails to meet the stated percentage, then they will have to pay a solar alternative compliance payment. They can, however, avoid such a payment by acquiring Solar Renewable Energy Certificates (“SRECs”). Each solar generation facility earns one SREC for each megawatt hour of solar generated electricity.15 SRECs are tradable and can be sold like any commodity. Typically, SRECs are owned by the owner of the solar generation system.16 Similar laws pertaining to the sale of renewable energy certificates or credits exist in a number of other states, including Connecticut, Delaware, Massachusetts, Maryland, Ohio, Pennsylvania and Washington, D. C. In Hawaii, the utility must pay a feed-in tariff for each kWh of electricity generated by the solar generation system.17

More than half the states authorize solar easements that are designed to protect a solar generation project’s continuing access to sunlight.18  Solar easement legislation varies among the states from the authorization of voluntary grants such as in New Jersey and Massachusetts, to a requirement for a grant in New Mexico, to an ability to compel a grant by payment of fair value if a voluntary acquisition can not be achieved as in Iowa, to the creation of a nuisance claim under California law if a neighboring tree or shrub shades a project by more than 10%.19 Other state and local legislation and incentives include20:

Federal Initiatives

The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the interstate sale of electricity. Net metered projects that do not involve the sale of electricity to a utility are not subject to the regulatory requirements of FERC. FERC also provides for a reduced regulatory oversight of “Qualifying Facilities” as defined by the Public Utilities Regulatory Policy Act of 1978.22 FERC provides for special regulatory treatment of solar facilities that are 80 megawatts or less and allows for such facilities to “self-certify” such status. In addition, FERC exempts from the self-certification process those projects that are 1 megawatt or less.23

The most significant initiatives at the federal level are the 30% investment tax credit for solar projects put in service on or before December 31, 2016, the 30% cash grant (now expired, but available for those that met the safe harbor before January 1, 2012) and the ability of solar generation facilities to accelerate depreciation of eligible solar renewable energy equipment over a 5 year period.24

Due Diligence Issues

The evaluation of whether to install a solar generation system involves an examination of a number of issues including, (a) the economics of the transaction, (b) the system details concerning type and location and the resulting concerns, (c) permitting issues, (d) utility issues, (e) warranty issues, (f) selection/approval of the system installer, and (g) continuing operation and maintenance of the system. The due diligence examination should begin with a review of the lease agreement, if the property is not owner occupied. How does the lease address billing for electricity? Is the electric meter in the name of the property owner/landlord or the tenant? Is the lease a gross lease or a net lease? Can lease modifications, if required, be effected so that the property owner/landlord does not incur the capital cost of a solar generation system without the benefit of a lease structure that enables the sale of the electricity to the tenant? Does the property owner/landlord have control of the roof or other areas of the property at which the solar generation system components will be located, including access to the roof and any interior space necessary for related wiring? Regardless of whether the property owner plans to develop and own the solar generation system or provide space on its property for a third party to develop the system, due diligence will be necessary.

Transaction Economics

Transaction economics require close scrutiny in order to make the threshold determination whether to develop and own the solar generation system or enter into a Power Purchase Agreement in which a third party will develop and own the solar generation system and power will be purchased at a reduced rate. In this instance, the following issues need examination:

System Details

It is necessary to evaluate the types of solar systems that are available for installation at the particular site, the available location of such an installation, the related potential consequences of each alternative and the annual degradation of each type of system. There are 3 types of solar systems that can be installed at a site-rooftop, ground-mount and parking canopy. In determining which type of system to select, there needs to be an evaluation of the potential size of the system depending on the type. The answer will impact roof space, land space or parking space needed and the resulting energy output and payback. For each type of system, it is necessary to evaluate the site and neighboring properties to determine whether there are any shading issues that cannot be overcome, or may need to be protected against by way of a solar easement (assuming there is a statutory basis for such in the jurisdiction in question).

Rooftop system:

A rooftop system requires an engineering analysis of the roof and building structure and roof condition to determine whether any engineering will be required to ensure structural integrity. Because the roof will be covered with panels, roof maintenance and repair become problematic. Most often a new roof will be installed in connection with the solar system installation. The cost of a new roof also must be accounted for in the economic evaluation of the installation. If a fairly new roof exists then it will not be necessary to install a new roof; however, there must be an investigation of the measures required by the roof material manufacturer to ensure the continued validity of the existing roof warranty. This may also be required in connection with a new roof installation. The following additional issues should be examined in connection with a rooftop system installation:

Ground-mount system:

A ground-mount system requires an examination of a number of issues, including: 

Parking canopy system:

In  addition  to  the  issues  above,  a  parking  canopy  system  requires  an  examination  of  the following issues:

Approval/Permitting Requirements

It is important to determine who will apply for and have responsibility for securing approvals and permits - the installation contractor or the system owner.

Regardless of where responsibility rests, it is important to identify state and local requirements for system development, including requirements for net metering registration, registration to sell solar renewable energy certificates or credits, and requirements for other available environmental attributes. Further, state and local approval and permitting requirements need to be evaluated to determine the process, timing and any sequencing requirements. For example, in New Jersey, in order to secure an interconnection agreement with the local electric distribution company, upgrades to the utility distribution system must be paid for by the applicant. Also, in New Jersey certain registration requirements must be met relative to SREC registration prior to commencement of construction and construction must be completed within a specified period following registration. It is also important to evaluate the local zoning requirements. In addition to zoning issues discussed above under System Details, determine whether zoning approval requires a public hearing and if so, evaluate the timing and likely public reception in order to plan for potential resistance.

Warranties and Guaranties

In evaluating the issue of warranties and guaranties, review the following:

Contract Installer Information

Issues to examine in connection with the contract installer include:

Operation and Maintenance

Issues to examine in connection with system operation and maintenance include:

Project Documents – Engineering, Procurement and Construction Agreement

In a first party ownership structure, the property owner or operator builds and owns the system (usually through an affiliate). In such a transaction, the solar system owner enjoys a number of benefits, including (a) free electricity (the benefit of which will turn on demand and electricity pricing in the jurisdiction), (b) ownership of all environmental attributes, such as renewable energy certificates or credits or feed-in tariffs, (c) the federal tax credit or (depending on the date that work on the project commenced) the federal cash grant, and (d) depreciation benefits. With these benefits comes certain “detriments” including (a) up front capital cost of construction, (b) on-going operation and maintenance responsibility, (c) added insurance costs to cover the system and production down time resulting from a fire or other insured casualty, and (d) jurisdiction depending, added real estate taxes.

In a first party ownership structure, the property owner or operator (usually through an affiliate) enters into an engineering, procurement and construction agreement (“EPC Agreement”  or “Solar System Installation Agreement”) with a contract installer. It is necessary to have an understanding of the project jurisdiction’s laws in order to ensure that the EPC Agreement properly addresses requirements for interconnection, net metering and, if applicable, renewable energy certificate or credit requirements, as well as any other jurisdictional requirements pertaining to the solar project and related environmental attributes. For example, in New Jersey the system must include a minimum of a 5 year warranty for solar renewable energy certificate approval. In addition, depending on the project size, prevailing wage requirements must be satisfied. Among the many issues to be evaluated and addressed are the following:

Definitions

A close examination of the definitions is essential. As used below, “System Owner” refers to the property owner or operator that will own the solar system and contract for its development and “System” refers to the solar generation system to be constructed.

Agreement should include a project schedule that addresses the timeframe for final completion, and the consequences if final completion is not achieved by a date certain, particularly if that results in a loss of critical project funding/incentives.

Pricing, Payment and Change Orders

The EPC Agreement should clearly state the project cost. Pricing is usually based on a per watt basis. Because the final system size may not be known when the EPC Agreement is entered into (because engineering and final plans and specs are required) it is important that the system have a maximum and minimum size. The system should not be so small that the cost/effort is no longer worth while and not so large that the cost is greater than what the property owner/operator can afford. It is also important to provide that the stated cost includes obtaining an interconnection agreement with the local utility and any related studies and system upgrades.

Payment should be conditioned on specific milestones of construction and equipment delivery. Before payment of any significant amount is made it is important to make sure that the following have been secured: (a) a building permit; (b) an electrical permit; (c) net metering approval; (d) an interconnection agreement with the local utility; (e) a zoning permit, if required; (f) registration for renewable energy certificates or credits, if required. It is also important to coordinate payments with any applicable draw timeframes under any construction financing. If a payment amount is disputed, provide for a right to withhold or escrow the disputed amount and that the contract installer will continue performance notwithstanding the disputed payment.

Beware of provisions that make change orders automatic if there is (a) a force majeure, (b) a change in law or (c) a breach by the property owner/operator of the agreement. If a change order for a force majeure is agreed upon, make sure that the situation is limited to an uninsured force majeure. If a change order is allowed due to a change in law, make sure that the change in law is not that which a contractor could or should have anticipated, such as any change resulting from pending legislation or proposed regulations. If a change order is allowed due to a breach by the property owner/operator, make sure that it is of a material nature, results in an adverse financial impact that was not reasonably avoidable by the contract installer and only follows a cure period.

The agreement should clearly state that changes in “Work” are only permitted by way of a written change order. Any change order issued should include (a) the details of the factors necessitating the change, (b) the impact on the contract price, and (c) the impact on the project schedule. The property owner/operator will want approval rights for any change order; however, the contract installer may want an absolute right in the event of concealed or unknown conditions at the project site.  Unknown conditions should be limited to latent conditions.

A property owner/operator should reserve the right to make changes so long as they do not adversely affect (a) energy output, (b) the validity of any warranties, (c) the contract installer’s warranty or (d) site conditions.

Scope of Work

The body of the EPC Agreement should require the contract installer to furnish all Work (a) in accordance with the terms of the agreement, (b) pursuant to the Statement of Work, (c) in accordance with good industry practice and (d) necessary to complete the System and achieve Final Completion. On rooftop projects, the EPC Agreement should address the responsibility of the contract installer relative to the existing roof warranty.  Many roof manufacturers today have a protocol in place to approve an installation and confirm in writing the continuation of the roof warranty. The obligation to satisfy the roof manufacturer requirements should rest with the contract installer.

Contractor Responsibility

In  addition  to  completing  all  Work  and  achieving  Final  Completion,  the  contract  installer responsibility should include the following:

Title and Risk of Loss

Usually, title passes to the property owner/operator on the earlier of payment or delivery of the equipment to the project site. The property owner/operator will, however, want the contract installer to retain the risk of loss until final completion. Consequently, the structure of the builder’s risk coverage outlined above under “Contractor Responsibility” is particularly important.

Default and Remedies

When drafting the default provisions of the EPC Agreement, make sure the cure period cannot result in a loss of environmental attributes or any governmental incentives. Also, beware of provisions that entitle the contract installer to the value of any work performed and not paid for even in the event of contract installer default. If the net damages suffered by the property owner/operator are less than the value of unpaid work then perhaps the contract installer should have a claim, but similarly if the property owner/operator defaults and the value of the work paid for exceeds the net damages suffered by the contract installer, then the property owner/operator should have a claim for reimbursement.

Typically, an EPC Agreement will exclude consequential damage claims. There should, however, be a carve out for (a) claims of third parties subject to indemnity under the EPC Agreement, (b) a breach of a confidentiality provision, (c) claims covered by insurance to the full extent of the insurance coverage required under the EPC Agreement, (d) damages due to a loss of a manufacturer’s warranty arising from the contract installer’s default, and (e) loss of environmental incentives and projected energy savings.

EPC Agreements also frequently limit the liability of the contract installer to the payments required under the EPC Agreement. Such a provision should be revised to include the consequential damage carve-outs and actual damages incurred to complete the project, including (a)  removal, replacement and installation of equipment, (b) cost to correct deficiencies to ensure performance of the system and/or issuance, validity and/or continuation of warranties, and (c) any additional cost for manufacturer warranties or replacement contractor warranties.

Warranty

Generally, the System Owner wants to know: (a) that the solar system is warranted to have been designed, engineered, constructed and installed in a good and workmanlike manner, consistent with good industry practice, using new materials, (b) that the work was performed in conformance with the requirements of the agreement, the plans and specifications and all warranties, (c) that the work will be free of defects in design, engineering, material and workmanship for the warranty period, and (d) that the equipment, other than that for which there is an independent third party warranty, is in conformance with the requirements of the EPC Agreement, and is free from defects in its design, engineering, materials and workmanship for the warranty period.

There is no bright line with respect to system output. This is a frequent topic of hot debate, as the contract installer will argue that responsibility for any deficiency should rest with the panel manufacturer.

When reviewing the contractor installer warranty, be careful to review the concept of “defect.” Frequently, defect, as defined, will be limited to inferior workmanship rather  than  inferior design, engineering, materials and workmanship.

Be careful that a failure to give notice of a defect within a set timeframe does not negate the contract installer warranty. Failure to give timely notice should not terminate the warranty unless the contract installer can show material prejudice. In addition, the warranty period should not commence until Final Completion and should be extended for a period equal to the period of non-conformance. If any repair or replacement is effected under the warranty, the access should be governed by the same access terms as the initial construction, and the work should be warranted for the longer of the remaining warranty period or 12 months.

The EPC Agreement also should obligate the contract installer to assist in any third party warranty claim. In addition, if that claim is rejected due to faulty workmanship or unauthorized personnel performing the installation, the contract installer should be obligated to remedy the defect consistent with the terms of the third party warranty, and the obligation should have the same duration as the third party warranty.

Finally, if the contract installer is undertaking the on-going operation and maintenance of the system, then the contract installer should bear the risk of any failure to maintain in accordance with the prerequisites of any third party warranty.

Project Documents – Site Lease

In a third party ownership structure, a third party owns the system. Depending on whether the meter is in the name of the property owner or building operator(s), that party (the “Off-Taker”) will purchase the power from the system owner or power provider (the “Provider”) via a power purchase agreement. When the Off-Taker is a party separate from the building owner, the building owner (the “Host”) will enter into a site lease with the Provider granting the Provider the necessary right of entry to construct, operate and maintain the solar generation system on site. If the Host and the Off-Taker are one and the same, then the relevant terms of the site lease can be addressed in the power purchase agreement.

In a third party system ownership, the Provider builds and owns the system and enjoys the benefits, including (a) the proceeds from the sale of the electricity (which presumably will be sold to the Off-Taker at a rate less then the rate of the local utility company or the project would not be approved by the Host and Off-Taker), (b) ownership of all environmental attributes, such as renewable energy certificates or credits or feed-in tariffs, (c) the federal tax credit or (depending on the date that work on the project commenced) the federal cash grant, and (d) depreciation benefits. The Host avoids responsibility of ownership, including (a) up front capital cost of construction, (b) on-going operation and maintenance responsibility, and (c) added insurance costs to cover the system and production down-time resulting from a fire or other insured casualty. The benefit for the Host of this structure is that it can entice tenants to its building by having available less expensive electricity while at the same time, depending on the structure, receiving a roof rent or a new roof, or some combination thereof. This structure is one available structure for a Host that cannot take advantage of the federal investment tax credit because it is a not-for-profit entity or a non-taxpaying entity.

In a third party ownership structure, the Provider selects the contract installer and enters into the EPC Agreement; however, it is not uncommon that the contract installer first establishes a relationship with the Host, and actually secures the site and then brings the deal to a pool of investors that it works with to move the deal forward. This structure has increased in popularity, particularly with the demise of the federal cash grant.27

The determination to construct and own versus a third party ownership structure turns on a number of factors, including, whether the property owner is a taxpaying entity with a tax credit appetite, and the balance between the interest in energy efficiency versus the cost, after accounting for rate of return and factoring in available federal and state incentives and the local cost of electricity. When the scale tips in favor of third party ownership, then the balancing shifts to the interest of the Provider in access to the building for construction, operation and maintenance purposes, the ability of the Provider to finance the project, the requirement for a purchaser of all of the generated power and the ability to maximize the monetization of all available environmental attributes. That interest must in turn be balanced against the Host’s interest in preserving the financability of its real estate, the desire to only grant rights to the Provider that are necessary for it to satisfy its interests without any greater real estate interest, the continuing ability to access its roof (in the case of a rooftop project) and undertake any required roof maintenance without added cost, the ability to efficiently and effectively operate its primary business – real estate leasing, and the ability to offer its tenants less expensive electric power.

When structuring a site lease for a solar project, all of the traditional real estate leasing issues are as relevant to a site lease for a solar project as they are to any other tenancy. In addition, make sure that the mortgage lender agrees with the concept of a solar project and site lease as well as the related inter-creditor arrangements required for a solar project, which is discussed below in the section titled “Relationship Between Property Owner, System Owner, Mortgage Lender and System Lender.”

Below is a general outline of some of the more significant issues to address in a site lease from the perspective of the Host.

Premises

It is not uncommon to see a mix of grants within the premises conveyance section of a site lease. Some of the more onerous provisions that should be addressed, include:

The foregoing grants are not only overly broad, but they are not necessary to the Provider’s interest in securing the site to develop, finance and operate the agreed upon solar generation system, and are detrimental to the on-going business interest of the Host to retain use of its roof, access to its mechanical systems, and be able to lease and finance its real estate.

If the project involves a rooftop system, then the leased premises should be limited to the area of the roof over which the system will be installed and the area for the system inverter. The use of common facilities, such as means of ingress and egress to the roof, building risers, and building electric room, can be addressed by way of a grant of the right to use such common areas in common with others.

In addition, it is important to provide for a lay-down area for construction staging in order to ensure that the on-going day to day activities of tenants and their invitees are not disturbed.

Use

It is not uncommon to see a Use Clause that grants the Provider the right to use the premises (a) for any lawful use or (b) for solar energy conversion, collection and transmission of power or any other similar purpose or activity. The use clause should be specific. In a solar site lease, the document should clearly limit the use to the construction and operation of a solar electric system of a stated size, for the purpose of collecting and transmitting power to the building on the property.

Most site leases include a right of the tenant to conduct testing and an investigation to determine the feasibility of the construction of a solar generation system. The tenant has a legitimate interest in undertaking an investigation and evaluation of solar radiation, meteorological and geotechnical data (the latter where a ground-mount system is intended) and other studies to evaluate  and  determine  the  feasibility  of  the  project  from  a  technological  and financial perspective. But, make sure that the right does not extend to a wholesale environmental investigation. While a Host may have an interest in reduced energy costs, it has no interest in the discovery of previously unknown contamination.

Usually within the use clause (or elsewhere within the site lease) there will be a provision granting the tenant a broad construction right. For example, the following is language from a solar site lease reviewed by the author:

Tenant shall have the right to construct, install, improve, replace, relocate within the Property, and remove from time to time, and maintain, use, monitor and operate existing, additional, or new solar energy collection cells, panels, mirrors, lenses and related facilities and future technologies, all for the generation of electricity from sunlight.

The provision “relocate within the Property” arguably expands the tenant’s rights to  areas beyond the Premises. Similarly, the right to install “additional” equipment gives the tenant the right to expand the size of the system. The right to install “future technologies” leaves open a host of issues, including questions concerning size, safety, efficiency, building impact, noise, and sightliness. With any supplemental installations, the same standards that governed the initial installation must also govern any subsequent installation.

Some additional “hot button” provisions to watch for include:

Use provisions will also frequently include provisions granting to the tenant an easement to (a) use the building equipment room and building risers and raceways, (b) access, ingress to and egress from, and over the building and property and the right to use any utility, transmission and other easement and right of way held by the Host/landlord, and (c) conduct tests and inspections on and over the building and property as the tenant deems useful. It is incongruous to express the foregoing grants in terms of an easement. To the extent any of the foregoing rights are provided, they should be granted by way of a limited (scope and duration) right, to be exercised (at least in terms of items (a) and (b) above) in common with other occupants of the property.

Use provisions also frequently include an exclusive right of the tenant to all solar resources at the property and the exclusive right to conduct all solar operations on the property. In addition, the clause typically provides that the Host/landlord will not interfere with or construct or permit construction of any structure that will block or impair the solar resources at the property. The exclusive use provision can come into play in a number of settings, depending on the precise language of the site lease. Does the tenant have an obligation to build in the first instance? If the Host/landlord constructs a building addition or acquires adjoining property will the tenant control solar development in those settings? If so, if the tenant does not construct a solar system, will the Host/landlord then have the right to lease to a third party to develop a system? If the solar generation system is a ground-mount system, will the tenant have the responsibility to bring the power to the new building addition? All of these questions must be addressed if the tenant receives an exclusivity right.

Regardless whether the tenant is granted exclusivity, it is important to make sure that tenant has an obligation to continuously operate. The true value of these projects to a Host/landlord is less expensive electricity. Consequently, if the tenant does not continue to operate, the Host/landlord should have the right to secure a new system and new operator.

Term

Many site leases break down the term to a “pre-operating period” that commences on signing and continues until the solar generation system is constructed and operational. At that time the basic lease term will commence and will usually run for a 15 to 25 year term. It is important that the pre-operating period have a finite term. If within that term (usually 6 to 12 months) the solar generation system is not constructed and operational then the site lease should terminate.

It is also not uncommon to review a site lease that grants a tenant the unilateral right to terminate at any time. That right should not extend beyond the pre-operating period, should terminate upon a tenant default and should tie in with the power purchase agreement so that if one agreement terminates, the other does as well.

Payment

Payment under the site lease varies widely depending on whether the Host/landlord receives a new roof as a part of the deal and whether the primary purpose is less expensive electricity for the building without regard for a rental income under the site lease. Payments under the site lease should be characterized as rent. Rent may be determined in any number of ways, including on a per square foot basis or the number of kWh of electricity sold from the system. If the rent calculation is based on the kWh sold from the system, then it is important that the parties determine how they will address a casualty event that affects only the system.

Solar Generation System

The solar generation system installation provisions of the site lease require careful review and should provide the following:

The site lease also must address the removal of the solar generation system and site restoration. The lease should (a) clearly address the removal obligation (including panels, racks, wires, inverters, etc.), (b) impose a timeframe for completion (since the removal and restoration period normally will not begin until the end of the term), (c) provide for Host/landlord approval of a decommissioning plan, that includes building restoration, (d) require final lien waivers, (e) address abandonment so that if any parts of the system are left in place the Host/landlord can dispose of them without liability to the tenant, and at the tenant’s expense, and (f) address security for the performance of the removal and restoration obligations, and timing for posting (on signing of the site lease, on the commercial operation date of the system or some later date). If the system is a ground-mount or a canopy type system, then the lease also should address (a) removal of support structures and footings, (b) removal of any below ground installations, (c) if below ground installations are not removed, then disconnection of all lines and capping of all lines so that no electric current is running through any installations and all remaining installations are flush mounted, and (d) any replanting obligations. The site lease should also address the right of the Host/landlord to buyout or require a surrender of the system at the end of the site lease term.

Repair and Maintenance

Frequently site leases impose a broad maintenance, repair and replacement obligation on the Host/landlord, but only require the tenant to maintain the solar generation system consistent with industry custom. The Host/landlord, to the extent that it is structuring the deal around inexpensive electricity, will require that the tenant has an obligation to not only maintain, but also to repair and replace the system.

A hotly debated issue in site leases turns on system shutdown and relocation for Host/landlord work on the roof.  The debate centers on (a) who will relocate the relevant sections of the system, (b) what amount of prior notice is required, (c) who will pay for the relocation, (d) is there a black-out period during which relocation and shutdown cannot occur (e.g., summer months or initial 5 year period following installation), and (e) will the tenant be entitled to reimbursement for lost energy sales, lost renewable energy certificates or credits, or other lost environmental attributes?  These are important issues for each side and there is not a one shoe fits all solution.

Casualty and Condemnation

It is important to note that the tenant will have a substantially greater investment in the system than most tenants have in the typical tenant improvement scheme. Consequently, expect that the tenant will want to impose a substantial burden on the Host/landlord to rebuild if the tenant does not exercise a termination right. In addition, the tenant may want to pursue a claim in condemnation for the full value of its system, moving expenses and business dislocation expenses. A Host/landlord nevertheless must always answer to the ultimate authority - its mortgage lender - therefore in the casualty setting, a tenant should be pushed to take advantage of the new and broad protective policies available in the market which address lost energy sales, lost sale of renewable energy certificates or credits, lost environmental attributes, lost tax value of depreciation and tax credit/tax grant recapture.

Default and Damages

Default and damages provisions are not substantially different from other leases.  Consider including, however, the following:

Assignment

There are a number of issues the Host/Landlord should evaluate in a site lease including:

Taxes

Some jurisdictions exempt the value of the solar generation system from the determination of a building’s value for real estate taxes. For example, New York exempts systems from factoring into the determination for residential single family to 4 family units. In New Jersey renewable energy systems are exempt from real estate taxation. A renewable energy system includes equipment that is a part of or added to a “…commercial … or mixed use building as an accessory use and that produced renewable energy onsite to provide all or a portion of the electrical…or general energy needs of that building.”28 The laws of each jurisdiction must be examined to determine if any filing is required in order to take advantage of an exemption. In addition, the laws of each jurisdiction must be examined in order to ensure that if the system is not exempt, the parties address payment responsibility.29

Project Documents – Power Purchase Agreement

In a third party ownership structure, a third party owns the system and the Off-Taker will purchase the power from the Provider via a power purchase agreement (“PPA”). The Off-Taker avoids responsibility of ownership, including (a) up front capital cost of construction, (b) on- going operation and maintenance responsibility, and (c) added insurance costs to cover the system and production down time resulting from a fire or other insured casualty. For the Off- Taker, the benefit is the lower cost of electricity.

Many of the issues applicable to the EPC Agreement and the site lease are also applicable (with some slight modification) to the PPA. The following discussion focuses on some of the more significant issues to address in a power purchase agreement, from the perspective of the Off-Taker, that are not otherwise addressed in the above discussions concerning the EPC Agreement and the site lease.

Conditions Precedent

Some PPAs contain a provision that conditions the Provider’s obligation to develop the solar generation system and deliver power on (a) the receipt of board or management approval, (b) the receipt of a commitment for third-party financing, (c) the receipt of interconnection approval or (d) approval of the financial creditworthiness of the Off-Taker. If a condition precedent is agreed to, there should be a specific timeframe for the satisfaction of each condition. In addition, the PPA should be clear that the Off-Take will not incur any financial obligation until the conditions precedent are either satisfied or waived. Be alert for a provision that gives the Provider a right to a credit enhancement if it is not satisfied with the financial condition of the Off-Taker, such as a letter of credit or a cash deposit equal to one to two years estimated energy costs. The PPA should be structured so that the obligation is not fixed at the discretion of the Provider. If the Provider determines it is unsatisfied with the financial condition of the Off- Taker then the PPA structure should provide for termination if the parties are unable to agree upon a credit enhancement.

Term 

The term should match with the term of the site lease. Some PPAs will include a set of circumstances that permit early termination by the Provider and impose, under such circumstances, an early termination fee on the Off-Taker. If a right of early termination is provided for, the PPA must state that the corresponding right to an early termination fee is limited, if at all to a circumstance involving the Off-Taker’s default. This author has reviewed PPAs that grant a Provider an early termination fee in the event of a default of the Off-Taker and also in the event of a casualty, condemnation and change in law. These early termination fee provisions have typically been designed to place the Provider in the position it would have been had the agreement gone through the period necessary to realize fully the federal benefits of accelerated depreciation, tax credit or cash grant, and the corresponding proceeds that would have been realized during that timeframe from energy sales and renewable energy certificate or credit sales. If an early termination fee provision is agreed upon, then it should be deemed a liquidated damage provision so that the Off-Taker will not be liable for any further damages. In addition, if an early termination fee provision is agreed upon, then the issue of consequential damages and any limitation of recovery on the part of the Off-Taker due to a Provider default needs to be drafted for parity.

Purchase of Power

Typically, a PPA requires the Off-Taker to purchase all of the power generated by the solar generation system. This raises the issue whether there are any maximum production limitations. The system is typically sized to the historic use of the facility; however, if the Off-Taker or Host recently undertook any significant energy efficiency measures, then the system sizing/capacity should be reviewed. In addition, the corresponding concern of minimum production requirements should be reviewed in order to ensure as best as possible that the system will produce maximum energy efficiency and the cost of electricity is reduced to the lowest possible cost.

The Off-Taker should beware of any “after tax basis payment obligations.” This provision obligates the Off-Taker to compensate the Provider in the event the system is shut down in whole or in part due to the Off-Taker, for example during a roof repair. Payment therefore is calculated on an after tax basis. To the extent payments that would have been made had the system not shut down would have been on a pre-tax basis, the compensation payment should not be any different. Also, the simple fact of imposing a payment obligation on the Off-Taker for an Off- Taker forced shut-down raises the question whether the Provider should compensate the Off- Taker for the payment of a higher energy cost due to a Provider caused shut-down, such as for a voluntary or involuntary outage.

The parties should review the laws of each jurisdiction to determine if there are any applicable taxes that will be imposed on the transaction, such as a sales tax on the electric energy charges.30 Pricing can follow any number of methods, including a percentage of retail energy costs or a fixed price per kWh with an annual percentage increase. In no event should the price per kWh exceed the average weighted price that power can be purchased from either a competitive energy supplier (other than the local electric utility supplier, if applicable) or the local electric utility. There will of course be a debate whether transmission charges, societal benefit charges or the like, and related tariffs should be included in the pricing determination because transmission lines are not being used in the transmission of power from the solar generation system to the building distribution system.

Also, PPAs will frequently provide for change in law. If a change in law results in a direct material change in Provider’s cost to provide solar electricity, the Provider will want the parties to negotiate an adjustment to the kWh rate. First, the PPA should carve out any change in law that impacts environmental attributes, including solar renewable energy certificates or credits. The Off-Taker should not be the Provider’s partner in the deal - particularly a one-way partner sharing only in the losses. Second, to the extent that the concept of change in law is included in the agreement, then a reasonable solution is a price adjustment based on fifty percent of the impact so that Provider and Off-Taker essentially split the loss. Some swap products are now available to transfer the risk of a change in law to a financial counter-party for a fee that is either paid by one of the parties or split by both of the parties.

Metering

The PPA Provider will install a meter to measure the electricity flowing from the solar generation system to the building electric distribution system. The PPA should provide that the meter will be kept under seal and not broken unless the meter is being tested or repaired/replaced. An Off-Taker should require that the Provider notice the Off-Taker of any testing. The PPA should provide for meter testing at an agreed upon regular interval, should enable the Off-Taker to require testing at no more than an agreed upon frequency and should provide that if a determination is made as to inaccuracy, that an adjustment will be made if the inaccuracy is determined to exceed an agreed upon percentage.

Maintenance

The maintenance obligation of the Provider will typically require the Provider (a) comply with law and (b) follow prudent operating practice, which means “the practices, methods and standards of skill engaged in by a significant portion of the solar electric power industry for similar size facilities at a particular time, expected to accomplish the desired results.” Concerns with this maintenance structure include:

There should be a clear covenant by the Provider to maintain, operate, repair and replace the system throughout the term, and keep the system (and the property) free of liens, in compliance with law and in compliance with the interconnection agreement with the local utility.

Default and Damages

The PPA should contain a cross-default provision so that a default under the site lease constitutes a default under the PPA.

Some of the more “extreme” provisions to avoid include:

Casualty

The apportionment of responsibility after a casualty is extremely complicated and must address a number of issues for which there is not any singular solution. The variety of possibilities of issues is endless. The following are some of the issues requiring resolution:

Assignment

It is not uncommon to see a provision that limits the Off-Taker’s right of assignment. If the Off- Taker has managed to secure a right of assignment under its real estate lease, then it needs to consider matching the PPA provision with the real estate lease.

The Provider will typically have a right to assign to an affiliate, a person acquiring or succeeding to all or substantially all of its assets, a lender or a “Qualified Assignee” (which is a person that has or will contract with one that has experience in the operation and maintenance of a solar system). This clause does not address the size of the systems that the assignee may have experience in owning, a time-line for the assignee to contract with an experienced party, financial capabilities, an assumption of obligations in order to establish privity, and a notice obligation to inform the Off-Taker of the transaction.

Project Documents – Operations and Maintenance Agreement

The contract installer will often offer an operations and maintenance agreement (“O&M Agreement”) in conjunction with the EPC Agreement. In the early days of solar development, a contract installer might offer an O&M Agreement that included an initial 3 to 5 years term at little or no charge as an inducement for the more profitable EPC Agreement. Even now, when fees are collected from day one, the cost of the O&M Agreement is not particularly significant in the total picture of the transaction. As with other project documents, there are a number of issues to look for when reviewing an O&M Agreement, including the following:

General Inspection Overview

The following is a general overview of what should be included in a regular inspection:

Relationship Between Property Owner, System Owner, Mortgage Lender and System Lender

The key to the complicated and multifaceted relationship between the property owner, the system owner, the mortgage lender and the system lender is the determination in the particular jurisdiction that the system is and will remain personal property. The determination of when property that is affixed to real property should continue to be classified as personal property or be classified as a fixture and part of the real property is not an easy one.

Determination Whether Personal Property

In General Motors Corporation v. Linden31 the Court endorsed a three part test to determine when chattels become fixtures:

… the true criterion of a fixture is the united application of the following requisites: (1) actual annexation, or something appurtenant thereto; (2) application to the use or purpose to which that part of the realty with which it is connected is appropriated; and (3) the intention to … make a permanent accession to the freehold.32

The Court characterized this three-part test as a restatement of the prevailing American common law fixtures analysis, composed of the elements of affixation, adaptation, and intention. The issue of whether a solar generation system will be classified as real or personal property (at least under New Jersey law) requires analysis of these three common law elements, with an eye toward determining whether the personal property has become so affixed to real property as to be considered a part of it.

The element of affixation looks not only at whether property has been attached to real estate, but the manner and extent of that attachment. This is a highly factual analysis. The second element of the analysis is sometimes referred to as “adaptation.” The focus is the extent to which the personal property has been adapted to, or integrated into, the purpose served by the real property to which it is attached. In General Motors the Court noted that, as to business assets, real and personal property can be united for some business purpose without losing their distinct characters, distinguishing between chattels affixed to real estate that are devoted to business conducted on the property and fixtures devoted primarily to the real estate itself. Another factor in determining the extent of adaptation (and also affixation) is whether the personal property can be removed without material injury to the real estate or to the personal property. The final prong of the common law classification of fixtures is intention to make a permanent accession to the real property. In examining this element, the courts have looked not merely at the subjective intent of the owners but also at an objective view of the “ordinary intent.”33 Analysis of this element will look at outward appearances and physical facts, as well as industry and trade practices.

Subordination, Non-disturbance and Attornment Agreement

Attached as Exhibit A is a form of Subordination, Non-disturbance and Attornment Agreement (“SNDA”), to be entered into between the property owner, system owner and mortgage lender. Generally:

Property Owner and Mortgagee Waiver

Attached as Exhibit B is a form of Property Owner and Mortgagee Waiver to be entered into between the mortgage lender, the system lender and the property owner. Generally:

The system lender may also want the property owner to agree (a) to provide it notice of and an opportunity to cure any system owner default, and (b) that system lender is not obligated to assume any obligations of the system owner.

The parties may want all to also agree to an exchange of estoppel certificates upon request.

Conclusion

Solar transactions are complex and require that multiple parties work with a solution oriented approach if the varying interests of all concerned are going to be fairly addressed. Although complex, solar projects afford a property owner an opportunity to maximize the income from its real estate, enhance the marketability of its real estate and display a corporate commitment to the environment and sustainability.

© 2012 Jack Fersko.  Mr. Fersko is a member of Greenbaum, Rowe, Smith & Davis, LLP, where he Co-Chairs the Alternative Energy and Sustainable Development Group. The following provided much appreciated assistance in the preparation of this article: Ken Bills, Co-Chair of the Alternative Energy and Sustainable Development Group, Maura Blau, member of the Alternative Energy and Sustainable Development Group; and Marjan Disler, member of the Alternative Energy and Sustainable Development Group.

Footnotes

1 The number of companies preparing sustainability reports annually has increased between 17% and 20%.   43 Toxics L. Rep. (BNA), No. 44, at 2865, 2012.

2 Id.

3 Sky Stanfield, Erica Schroeder & Thad Culley, Sharing Success – Emerging Approaches to Efficient Rooftop Solar Permitting, Interstate Renewable Energy Council Inc.

4 Avery Fellow, Wal-Mart, Costco Are Top U.S. Retailers Using Solar Power at Company Facilities, 43 Env’t. Rep. (BNA) No. 36 at 2343 (September 14, 2012).

5 Id.

6 U.S. Solar Industry Makes Bright Future for Swedish Retailer, CommercialTenant’sLeaseInsider, November 2012.

7 Avery Fellow, Wal-Mart, Costco Are Top U.S. Retailers Using Solar Power at Company Facilities, 43 Env’t. Rep. (BNA) No. 36 at 2344 (September 14, 2012).

8 Yuliya Chernova, They Paved Paradise and Put Up A Parking Lot, Wall Street Journal, Sept. 17, 2012.

9 Solar systems may be developed on the vacant portions of rooftops. Rooftop developments are less visible than other forms of solar development and usually less expensive; however, as will be discussed further in this article, rooftop developments present a number of issues relative to roof structure and issues of access. Ground-mounted systems offer visibility to the community; however, such systems usually are more expensive than rooftop systems and impact topography and add to impervious coverage, potentially presenting additional development issues. Finally, there are parking canopy systems that offer a benefit of covered parking, but also are more costly than the rooftop development and, if not properly designed for, can present drainage/icing issues.

10 Net metering is known as behind the meter generation.  A solar system that is connected behind the electric utility customer’s meter, as distinguished from a system connected directly to the utility grid, is considered a net metered project. Net metering allows for the measurement of both electricity consumed from the utility grid and electricity sent to the utility grid because the solar system at a particular moment in time is generating more electricity than is needed by the customer’s facility. At that point, the meter will actually spin backwards. Typically, at the end of an energy year, there will be a “true-up” to determine whether there is any excess energy that went to the utility grid.

11 The following is not intended as an exhaustive analysis of the multitude of state legislation and incentives designed to promote solar development, but rather is intended to provide the reader with a general sense of the nature of the legislation and incentives established at the state level that have spurred solar development.

12 Database of State Incentives for Renewables & Efficiency, http://www.desireusa.org.(last visited December 9, 2012).

13 See New Jersey Electric and Energy Competition Act, N.J.S.A. 48:3-49 et. seq., as amended by the Solar Energy Advancement and Fair Competition Act, P.L. 2009, c. 289 and as further amended by the Solar Act of 2012, signed into law July 23, 2012, P.L. 2012, c. 24; See also N.J.A.C. 14:8-2.1 et. seq.

14 Energy year 2014 begins June 1, 2013.

15 Power is measured in kilowatts or watts while energy is measured in kilowatt hours. 1 gigawatt (“GW”) equals 1 billion watts, 1 million kilowatts and 1 thousand megawatts.   1 megawatt (“MW”) equals 1 million watts and 1 thousand kilowatts. 1 kilowatt (“Kw”) equals 1 thousand watts. 1 MW hour (“MWh”) equals 1 thousand kW hours (“kWh”).

16 See Pennsylvania Alternative Energy Portfolio Standards Act, 73 P.S. Section 1648.1 et. seq., as amended, ARRIPPA v. Pennsylvania Public Utility Commission, 966 A.2d 1204, Pa. Comm. LEXIS 79 (2009), In re Ownership of Renewable Energy Certificates (“RECs”), 389 N.J. Super. 481, 913 A.2d 825 (App. Div. 2007).

17 For an excellent discussion of solar development issues generally and solar-related financial incentives see Craig M. Kline, Ch.17 - Solar, inTheLawofCleanEnergy – Efficiency and Renewables, ABA Section of Environment, Energy and Resources, (2011, Michael B. Gerrard, ed.) (hereinafter “Kline”).

18 See Database of State Incentives for Renewables & Efficiency, supra.

19 See Kline, supra, at 405 – 406.

20 See generally, Kline, supra, Stanfield et al., supra, and Database of State Incentives for Renewables & Efficiency, supra.

21 The United States Environmental Protection Agency (“EPA”) has identified and mapped over 11,000 potential sites for the remediation and development of projects involving solar and other forms of alternative energy. The EPA handbook that includes such mapping can be obtained at http://www.epa.gov/renewableenergyland/docs/handbook_siting_repowering_projects.pdf.

22 Public Utility Regulatory Policies Act of 1978, 16 U.S.C.S. §2601 et seq. (1978).

23 See Kline, supra at 401 – 402; see also New York State Elec. & Gas Corp. v. SARA-NAC Power Partners, L.P., 117 F. Supp. 2d 211 (N.D.N.Y. 2000) for a general discussion of the exemption of qualified facilities from federal and state regulations.

24 For an in-depth analysis of the federal financial incentives see Valerie A. Blair and Mark S. Hennigh, Stick It Where The Sun Shines: Incentives For Installing Solar Facilities On Commercial Property, The ACREL Papers (The American Law Institute, Continuing Legal Education)(Spring 2013).

25 There are a number of sophisticated ownership/financing techniques that are available that are beyond the scope of this article, including a sale-leaseback structure and a partnership flip structure which effectively provide ownership rights and benefits to the equipment owner or allocate cash and tax benefits to the equity investor, as the case may be, for a set period of time after which ownership or allocation, as the case may be, shifts. For an excellent presentation of the various ownership and financing techniques employed in the clean energy setting, see Kline, supra at Ch. 17 and Bradon W. Penhoet, Chapter 10 - Financing Structures and Transactions, in The Law of Clean Energy - Efficiency and Renewables, ABA Section of Environment, Energy and Resources, (2011, Michael B. Gerrard, ed.).

26 It is essential to review carefully these policies. Some policies, marketed as protecting against a “loss of revenue from the sale of energy,” actually only insure against a loss arising from the sale of energy to the grid, which will not cover a net metered project. Also some policies provide that if a building is vacant for longer than a stated period of time, the policy’s “green components” are nullified. See generally Jack Fersko, Insurance Issues Affecting Green Development, ABA Probate & Property (Sept./Oct. 2010).

27 It is interesting to note that the title industry is now entering the alternative energy field. The industry has developed 7 new energy project related endorsements to address a wide array of transaction structures, including related loan policies. See Janice E. Carpi, Marvin N. Bagwell and Robert S. Bozarth, But Wait – There’s More! The New and Revised 2012 ALTA Endorsements and Update on MERS, The ACREL Papers (The American Law Institute, Continuing Legal Education) (Fall 2012).

28 N.J.S.A.54:4-3.113a.

29 See Watson Cogeneration Co. v. County of Los Angeles, 98 Cal. App. 4th 1066, 120 Cal. Rptr. 2d 421 (Cal. Ct. App. 2002) wherein the court found it proper for the county tax assessor to consider the income stream from an above-market price power purchase agreement in the property tax valuation.

30 See South Carolina Revenue Ruling 10-10, determining that a utility customer’s use of excess solar electricity “banked” by the customer with the utility is use of the customer’s own electricity and therefore is not subject to a sales tax.

31 150 N.J. 522 (1997).

32  Id. at 534, quoting Brearley v. Cox, 24 N.J.L. 287, 289, 1854 N.J. Sup. Ct. LEXIS 48 (1854).

33 R.C. Maxwell Co. v. Galloway Twp., 145 N.J. 547, 549 (1996).

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