This is the fourth part of a Q&A series with members of the KLG team highlighting key areas in which renewable energy project developers encounter pitfalls that can end up delaying or derailing projects. This part is presented by Brendan Beasley, who frequently serves as lead transaction counsel for solar M&A transactions -- deals involving purchase or sale of solar energy projects and portfolios. (A version of this piece was published in the Sustainable Bottom Line newsletter published by BerryDunn.)
What are key areas in which renewable energy project developers encounter pitfalls that can end up delaying or derailing projects?
Key areas in which developers face critical stumbling blocks include permitting and environmental matters, site control, interconnection, and preparation for project sale. Missing opportunities to timely and adequately tackle these challenges can increase project costs and even jeopardize an entire project.
What are common pitfalls that renewable energy developers encounter in preparing to sell projects?
Starting from infancy of a project through negotiation of an exit transaction, there are some common―and preventable―missteps developers need to avoid. These include: corporate housekeeping and contract missteps; underestimating time to obtain third-party items; striking the wrong balance in a solar M&A letter of intent; over-reliance on a develop-and-flip business model; undue optimism regarding project assumptions; inadequate protection against payment risk; and not covering bases with a co-developer.
What are examples of corporate housekeeping and contract missteps?
To a developer, the corporate side of project development is low risk and unexciting. Perhaps because of this, developers often neglect corporate matters. This is particularly common for developers without a full-time in-house counsel. Small mistakes can add up. Steps like forming a special purpose project company early in the development process and assigning any pre-existing project contracts or entitlements to the project company can be overlooked or postponed (and eventually forgotten) as a cost-saving measure.
Here are six common mistakes we see:
- the wrong entity executing a project contract;
- misspelling the project company name;
- unauthorized signatories (or incorrect title for the right signatory);
- failure to pay state corporate franchise fees;
- losing project documents and signature pages, or not fully compiling project documents; and
- inadvertently allowing liens against a project company or project assets.
These and similar issues can be resolved during the due diligence process, but this typically comes with additional legal costs and delay, is inefficient from a capital perspective, and can jeopardize a buyer’s confidence. There are various approaches to prevent issues and help spot issues in advance. For example, forming a project company is a fairly simple and repeatable process that a good set of forms and checklist can address. As a project moves to development-stage, periodic audits of your organizational and project documents by, for example, maintaining a living data room, will support a smooth transition to marketing your project.
Why should developers be concerned about third party items?
Third-party items always take longer to secure than you expect. For example, if you are selling a solar project, you will likely need landlord and offtaker estoppels and, if the deal is structured as a sale of assets, consents to assignment. You will likely need a title commitment and survey. A ground mount project will need a Phase I environmental site assessment, and, often, some sort of permitting report or opinion. An independent engineer report may be required. These are just a few examples of numerous third-party items that are common conditions to closing a solar M&A transaction or part of due diligence.
Lessen the impact of third-party items, and avoid surprises by attacking these items early. Securing estoppels, consents, reports, and opinions early, even if it becomes necessary to “bring down” or refresh them for the closing date, is immensely better than not initially securing them and leaving your project exposed to third-party risk. It is never too soon to raise third-party estoppels, as that sets expectations. If possible, create incentives or penalties tied to delivery by the third party. For example, estoppels can be addressed in some capacity in your project documents by establishing a covenant to deliver an estoppel within a certain number of days of request and including a form of agreed-upon estoppel. For consents, a project document can identify certain instances where consent is automatic, such as assignment of the document to affiliates, or to third parties meeting certain credit or experience thresholds.
What should developers avoid in a letter of intent?
Developers should avoid following the middle path in negotiating a letter of intent (“LOI”) for a solar M&A deal. Typically, the only two binding terms in an LOI relate to an exclusivity period and confidentiality. Nevertheless, there can be a lot of LOI deal term stickiness when it comes to drafting the definitive purchase agreement. As a result, we often recommend one of two approaches: (1) no LOI or a very skinny one; or (2) a detailed LOI. Factors such as transaction complexity, counterparty risk, potential repetition of transactions, and internal approval processes tend to dictate the right approach in any particular situation. A skinny LOI might have a shorter exclusivity period the parties can extend as they coalesce on terms and due diligence progresses. This approach establishes momentum toward due diligence and negotiation of a definitive agreement while allowing a quick off-ramp if needed. One place to avoid ending up, however, is with an LOI that was only lightly negotiated yet covers many deal terms. This scenario can leave a developer (or buyer) in a lurch if certain expected terms of a purchase agreement cannot be agreed upon and were not covered in the LOI or, worse, negotiated deal terms in the LOI are not agreeable to the developer’s management or investors. A project with a commercial operation date deadline, permitting deadlines, and/or a fixed incentive period can ill afford to be stuck in exclusivity with a counterparty unwilling to budge from agreed LOI deal terms.
What are risks of banking on a develop-and-flip business model?
Sure, most developers have no tax appetite, limited capital, and want to sell at the first possible opportunity. That’s fine. However, until that exit transaction occurs, the developer owns the project and should have an ownership mentality toward the project. Taking this approach can set the developer in the driver’s seat in purchase agreement negotiations by creating a viable, and perhaps even more valuable, alternative path if negotiations stall. Over-reliance on a prospective purchaser that intends to finance construction or insists on procuring key equipment can result in a situation where the buyer exerts leverage if a developer has no Plan B in place.
Having construction finance capacity or additional equity funding can markedly change the dynamics of post-LOI negotiation. If a developer does walk away from a solar M&A transaction without having continued development during the period under exclusivity, the developer losses time while often increasing project risk due to outside commercial operation dates and expiring incentives and permits. On the other hand, a developer that has moved forward on a project, and even entered construction, will de-risk a project leading to potential pricing upside.
What are risks of undue optimism in negotiating an LOI?
A typical pre-commercial operation solar M&A transaction involves a purchase price paid in milestones. Frequently, LOI-stage assumptions based on the expected state of the project at the time of signing the definitive purchase agreement turn out not to be accurate. While certain things, such as ultimate project size or property tax burden, are often the subject of mechanisms to adjust the purchase price if later conditions vary from an assumed baseline, it can be risky not to negotiate contingencies with respect to other items, such as whether an executed site lease (still in negotiation) or a key permit (subject to upcoming local board vote) will be in hand at signing. Developers tend to be optimistic. However, a developer may wish to agree on pricing or milestones at the LOI stage based on conservative estimates to protect itself if the parties are otherwise ready to sign a definitive purchase agreement. Contemplating both “base case” and “ideal case” pricing and milestones in the LOI can help ensure a developer’s management and investors are on board. It also avoids over-promising and under-delivering, which can be more harmful to reputation and may result in bigger discounts or deferrals of purchase price than if the base case were negotiated up front.
How can a seller protect against purchase price payment risks?
A developer must consider the creditworthiness and reputation of a project buyer and put in place necessary protections both to ensure payment of purchase price and continued development and construction of the project. A parent guaranty can not only decrease the general credit risk of the buyer, but, depending on the buyer’s corporate structure, can also result in independent management personnel’s reviewing a milestone payment dispute with fresh eyes. This unbiased perspective may be more realistic and potentially sympathetic to a developer’s claim for payment.
Other options to protect against risk of non-payment are project entity (or asset) buy-back rights and escrow agreements. In iterative transactions, such as ongoing sales of a portfolio of projects, a developer’s ability to offer future projects from the pipeline to the buyer on similar terms can act as a substantial incentive to the buyer to make payment. A common payment default scenario is a buyer’s unilaterally setting off against the purchase price for claims that may not have any merit. In this case, a buyer rarely has incentive to begin dispute resolution as it is holding the money.
Developer protections to address this issue, in addition to those discussed above, include restrictions on set-off (which may include requirement of developer written approval or commencement of dispute resolution), litigation fee-shifting, and meaningful deductibles on buyer claims.
What special concerns are at play in the case of co-developed projects?
If you have a co-developed project, be sure your development partner is on board before signing an LOI, even if you may have exclusive authority over project sales. Better yet, ensure that each partner signs the LOI. The benefits are two-fold. First, this can protect against a later disagreement with your development partner on deal terms and kick off discussions regarding allocation of risk between the co-developers in the event of post-closing claims. Second, this will give confidence to the prospective buyer that all necessary parties are in favor of the transaction.
FURTHER INFORMATION
For further information about solar M&A matters, please contact Brendan Beasley at bbeasley@klavenslawgroup.com or 617-502-6288.
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