Letters Of Intent For On-Site Solar Energy Transactions

Monday, February 10, 2014 - 16:20

An increasing number of retail, office, industrial and warehouse/distribution property owners are utilizing electricity generated by on-site photovoltaic (also referred to as "pv" or "solar") systems to meet a portion of their properties' electrical energy needs. The pv systems can be located on the roofs of buildings, in parking fields, on open areas of the property or on two or more of these locations.

One of the most common methods that property owners are using to obtain such on-site solar-generated electricity is to enter into a power purchase agreement, often referred to as a "PPA," with a solar developer, frequently referred to as a "provider." In a PPA, the property owner, often called a "host," provides leasehold or license rights on its property to the provider for the installation and operation of the pv system, and the provider sells the electricity that the pv system generates to the host. The provider generally owns all of the governmental and utility company incentives provided in connection with the pv system, and the host usually owns the net metering rights for the pv system.

However, the negotiation of a PPA frequently takes more time and is more complex than the economic benefits of the PPA to the provider and the host warrant. One of the major reasons for this problem is that the typical initial letter of intent ("LOI") for a PPA transaction frequently fails to address the issues that often cause the most difficulty when the host and provider attempt to negotiate and finalize the PPA itself. The balance of this article sets forth several of these additional issues that should be included in a PPA LOI and explores methods of ameliorating the conflicts they create between the provider and the host.

Electricity Rate Cap

Many LOIs include a cap on the rate that the provider will charge the host for the electricity that the pv system generates. The cap usually provides that the rate that the provider charges to the host cannot exceed the rate that that host's regulated local electrical utility, referred to in this article as the "Utility," or the host's third-party power supplier, charges the host for electricity at the property in question.

However, in setting this cap, it is important to remember that the Utility charges the host, whether or not the host also has a third-party power supplier, for many items other than the electricity itself, some of which are based on electricity consumption and some of which are static. Accordingly, when the host and provider agree on the rate cap in the LOI, they should clearly state what portions of the Utility and third-party power provider rate are included in determining the cap.

Interconnection Agreement

In order to operate a pv system and to obtain net metering for the excess electricity that the pv system generates, the Utility requires that its customer, usually the host, sign an interconnection agreement. The terms of the interconnection agreement are set forth in the Utility's tariff and are, hence, non-negotiable. While the host must sign the interconnection agreement, most of the undertakings in the interconnection agreement are the responsibility of the provider under the PPA. Accordingly, the LOI should provide that the host will sign the interconnection agreement and that each party will agree to perform its obligations under the interconnection agreement, while indemnifying the other party for its failure to do so.

Purchase Of Excess Electricity

Pv systems by their nature cannot provide all of a property's electricity needs all of the time. Additionally, in most jurisdictions, either the Utility or a government regulator limits the size of the pv system, so that it will not generate more than a maximum percentage (for example, 80 percent) of a property's electricity usage. However, notwithstanding these circumstances, there are times when the pv system will generate more electricity than the property is using, causing the Utility meter to run backwards, referred to as "net metering." In many jurisdictions, usually by means of the interconnection agreement, the Utility will pay the host or credit the host's future electric bills for the amount of this excess electricity.

For this reason, most PPAs provide that the host will purchase all of the electricity the pv system generates and own all the net-metering credits. However, before entering into a PPA, a host should review its third-party electricity supply contracts to make sure that they do not contain prohibitions against pv or other on-site systems or do not contain minimum usage requirements. The PPA and LOI should also address the situation where the property becomes vacant, because most net-metering programs have limitations on how much excess electricity the Utility has to buy.

Electricity Production Guaranty

Many hosts assume, in their financial planning for a property's operation, that the pv system will generate a minimum amount of electricity in each calendar year. Accordingly, they request a production guaranty. If the host wants a production guaranty, this should be set forth in the LOI. Additionally, the adjustments to the guaranty for weather, system shutdowns and force majeure events should be spelled out.

Taxes

Many jurisdictions provide limited sales and use tax exemptions on the sale of electricity from on-site pv systems and exclusions from increases in real property taxes by reason of their location on a property. However, other jurisdictions do not provide such exemptions or the exemptions are very narrow and do not apply to every situation.  Accordingly, the host and provider should determine whether or not a tax exemption exists or applies before they enter into a LOI. If the exemption is available, the LOI should set forth which party is responsible for obtaining it. If no exemption applies, the LOI should set forth which party is responsible for the particular tax.

SNDAs

Most properties are subject to mortgage secured debt. Under the Uniform Commercial Code, as adopted in most jurisdictions, the PPA can provide that the pv system is the personal property of the provider, not a fixture, and thus not subject to the lien of the mortgage on the property. However, most loan and security agreements for most mortgages also provide for security interests in the personal property located at the property. The language in these documents is often extremely broad. Additionally, the provider needs access rights over the property to install and repair the pv system and rights to place the pv system on the property. PPAs generally provide these rights as leasehold or license rights. Finally, many mortgages require mortgagee consent for the installation of pv systems on the property.

Accordingly, the LOI should set forth whether or not, and at whose cost, the host will obtain subordination, non-disturbance, attornment and lien waiver agreements ("SNDAs") from all current and future holders of mortgages on the property. Such a provision can provide for the sharing of the cost to obtain the SNDA between provider and host, with a waiver or cancellation option if the cost exceeds a certain amount.

Non-interference With PV System And Property Access

Many retail tenants, in particular, have consent rights over the roofs of their stores, rights to install HVAC systems and antennas on their roofs and exclusive rights over certain parking lots and common areas. The provider cannot allow its pv system to be moved, damaged or shaded. Additionally, the provider needs laydown, storage and parking areas for its installation, repair and maintenance of the pv system. Accordingly, the LOI should address tenant consents and lease and OEA amendments, if required, in order to insure non-interference with the pv system and necessary provider access. The LOI should also address which party is responsible for obtaining the consents and access and non-interference rights and at whose cost. Additionally, the LOI can provide for a non-penalty termination of the PPA if these consents and rights cannot be obtained.

Temporary PV System Relocation, Removal Or Shutdown

Most PPAs have a term of 15 to 20 years. During such a time period, roofs often have to be repaired and parking lots resurfaced. The cost to relocate or temporarily remove and reinstall a pv system is significant. Additionally, the cost to the provider in lost electricity revenue and more importantly lost incentive revenue can be substantial. Accordingly, the LOI should set forth which party will bear these costs or how they will be shared. Cost sharing may shift later in the term of the PPA because the provider's loss of incentive revenues will likely be less and the need for repairs will be more likely to occur.

PV System Purchase Options

If the PPA is going to provide for a purchase option, the LOI should address at what times in the term the host can exercise its option and set forth the method for determining the fair market value of the pv system at the time of the exercise of the option, including what factors will be used in determining the value of the pv system.

Assignment

The LOI should state when, under what terms and to whom the parties can assign their rights under the PPA and whether a party and, if applicable, its guarantor, remains obligated under the PPA after an assignment.  

Limitations On Liability

The LOI should specify whether the parties will be responsible for consequential damages, whether there will be absolute limitations on all damages, including indemnification obligations, and the dollar amount of these limitations.

Parental Guaranties

Most pv systems are owned through a single-purpose entity whose only asset is the pv system, and most shopping centers are owned by single-asset, single-purpose entities. Accordingly, the provider and the host should determine in the LOI if they are going to provide parental guaranties to each other and under what terms.

Conclusion

While the list of issues this article covers is by no means exhaustive, the author hopes that it will be helpful in streamlining the negotiation of PPAs.

Kevin J. Moore is a member of Sills Cummis & Gross.  He represents both providers and hosts in negotiating power purchase agreements for on-site pv systems.  The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Sills Cummis & Gross P.C. 

Please email the author at kmoore@sillscummis.com with questions about this article.