Solar PPA developers recognize host facility foreclosure is their big risk. The impact of that risk is bigger than many PPAs realize. Unless your PPA is set up right, a foreclosure does not just mean lost revenue. The foreclosing bank may be entitled to keep the solar as part of the building. Below are a few tips on how to avoid this devastating result.

Foreclosure Law & Rooftop Solar PV

Before explaining how solar PPA (Power Purchase Agreement) developers can protect themselves, let’s begin with a few basic legal principles. Most building owners are still paying off a mortgage on their building. They got that mortgage by offering their building as collateral to the bank. If the owner falls behind on his payments, the bank can foreclose on the building. Now here’s the scary part: When a bank forecloses on a property it gets to take the land, the building, and all the permanent fixtures attached to the building. Our focus is on this last part: permanent fixtures.

When many PPA developers think about foreclosure they understand they’ll lose the ongoing energy payments, but they assume they’ll be able to salvage some value by repossessing the solar. That is not necessarily the case. If the solar PV is deemed a “fixture” on the building, then the foreclosing bank may get to keep the solar just like it gets to keep the HVAC, carpet, and water heaters.

In other words, the PPA is facing an entire wipe out if the bank forecloses.

To put it simply, in a foreclosure:
1. If the solar is a fixture, the foreclosing bank may get to keep it.
2. If the solar is separate property (also called “personal property” or “chattel”), then the PPA developer get to repossess it.

“Is Solar A Fixture” Test

To determine what is a “fixture” vs “separate property,” there is a common sense definition and then the official three part test. The common sense approach helps understand the point of the test but, when structuring deals the PPA developer must build-in facts supporting each element of the technical test.

The common sense breakdown:

Separate Property (aka Chattels) are movable possessions and separate property. These are usually items that can be removed without injury to the host building.

Fixtures are improvements or items of separate property on the premises of the business that are attached to the host building, making them part of the building.

The technical test: Courts weigh three criteria to determine if something is a fixture:

1) Permanent Attachment:

The degree the solar is permanently attached?

Solar can be actually or constructively affixed to the building. Actual attachment can be through many means, such as, nails, bolts, adhesives, moldings, ties and other fastening. Even if the solar is not physically attached, it can have constructive attachment for example, when it permanently rests upon the building and is necessary for use of the building.

(2) Adaptation:

The degree the solar is adapted for the use at that particular building.

Solar will have a high degree of building-specific adaptation if:

(a) it is an integral and indispensable part of the building;
(b) it would damage the building if severed;
(c) the solar is highly customized in fabrication or installation to meet the specific criteria of the building where it is installed.

(3) Parties’ Intent:

Whether the parties (i.e. the building owner and the PPA company) intend the solar to remain separate property or to become a fixture is very important. The parties intent to keep it separate will control, unless the solar has been so absorbed into the building that its identity as separate property is lost.

The clearest way to show intent is for the lender/vendor and the building owner to agree in writing that the item is not to be treated as a fixture. This express intent will be the most important factor in the three part test, unless the solar’s separate identity is lost through its use. The separate identity can be lost when the solar cannot be removed without practically destroying the solar or the building, or when the solar becomes essential to support the structure to which it is attached.

Quick Application of the 3 Part Test: Solar Hot Water Systems

The law has not yet caught up to the solar industry. In one of the few court cases remotely addressing whether solar is a fixture, the court ruled that a solar thermal hot water system was a fixture. In reaching that conclusion, the court applied the three part technical test as follows:

1. Is it permanently attached?

Yes. The solar thermal system was permanently attached by bolts and connections to the building’s plumbing.

2. Is it adapted to the building?

Yes. The court found the solar water heater was specifically manufactured and fabricated for use with that specific building.

3. Did the parties intend it to be permanent?

Yes. The court said, if “the parties had intended the solar water heater to perform a temporary task, measures would have been taken to assure its easy removal from the [building].” Instead, the solar water heater was fastened with bolts, connected to the plumbing, and holes were drilled in the structure.

Of course, any solar PPA developer knows solar hot water is far more embedded in a building than rooftop solar PV. The key, however, is making sure your deal has the right facts to prove that to a court. So, now we’ll go over a few tips for generating those favorable facts.

Keeping Solar From Becoming A Fixture

The best way to protect your solar from being deemed a fixture is to design both the transaction and the installation for repossession. First, clearly articulate in deal documents that you have the right to remove the solar at the end of the PPA term or any time after default. Second, use plug and play installs instead of custom configuring each rooftop design, so that it can be redeployed at a later site. Third, design the array to be quickly removable without damaging the rooftop when it is gone. All deal documentation should acknowledge all of these efforts, to make clear your intention.

Let’s walk through the three part test to see how this works:

1. Is the solar system permanently attached?

It is hard to envision a commercial rooftop install that you could say for certain would not be considered permanently attached by a court. However, the degree of permanent attachment matters. Building integrated installs, such as glued on thin film sheets, will be hard to escape treatment as a fixture. On the other hand, ballasted systems with minimal attachments create a stronger argument that it retained a separate identity.

You can protect yourself by specifying how the different components will be treated. Parts of the installation can be fixtures, and other parts (i.e. the panels) can be separate property. There are a few things you can build into the system design to do this. Design a rooftop attachment that can quickly release the panels and racking. Agree in advance that in a repossession the attachments will stay and the panels go. Make sure to spell out which components stay, and which go. You could also set it up so that the permanent components are installed under a sale of goods to the building owner, while the separate property is installed temporarily under the site lease and power purchase agreement.

2. Is the solar adapted to the building?

Designing the system to be removed helps avoid the adaptation test in many ways. Here are three examples of how:

First, use a plug & play design, meaning it will work on any rooftop. Do not custom engineer the racking to fit around obstacles on the roof. Do not custom fab any components to satisfy the needs of just that building.

Second, use an installation method that does not damage the building upon removal. If you drill holes, have an agreed plan with the owner as to how they will be filled upon removal.

Third, build in components needed to remove the array. For example, add hoist hooks to frames so that the array can be removed by a crane. Use quick release wiring hooks that let you take the panels but leave the permanently affixed wiring conduits.

3. Did the parties intend the solar installation to be permanent?

The intent test asks “what did the parties intend,” and then was that intent trumped by using the item in a way that loses its separate identity. The steps above should help show the separate identity of the solar was not lost once installed. To show the parties’ intent, make sure all the deal documents consistently treat the solar like it is *not* a fixture.

This can involve a number of steps, including:
1. The site lease and PPA should have a provision where the building owner expressly states the solar is not a fixture.
2. The end of term removal provisions should be spelled out.
3. The steps the PPA provider must take to repair the roof upon a repossession or end-of-term removal should be defined in advance.

The PPA developer should record other facts that demonstrate that the solar is temporarily placed on that building’s roof. For example, it could:

1. Show how the solar racking was designed to comply with building codes in multiple jurisdictions.
2. Show a pattern of removing and redeploying other systems.
3. Document when components of the array are swapped out for repairs or efficiency upgrades.

Perfecting Your Interest

The final step is called “perfecting” your security interest. In other words, even if you’ve taken sufficient steps to ensure your solar will be treated as separate property, you’ll still need to put future purchasers and lenders on notice that you have the senior security interest in the solar. There are a number of options for doing this, including:

1. Recording an abstract of the site lease in the real property chain of title.
2. Filing a Financing Statement on the solar.
3. Filing a Fixture filing on the permanent attachments.

There a many different ways to perfect your security interest, and the process varies from state to state. The methods, strategies, and issues are complex, and outside the scope of this article.

Conclusion: Nothing Is Certain

Remember none of this is a guarantee. Solar PPAs and new efficient rooftop installation methods do not fit neatly into pre-existing buckets under the law. Existing law is based on older technologies that are not 100% analogous to the solar PPA model. Until the law settles on how to treat commercial solar PPA situations, the best advice is to the follow the basic principles from prior cases. Hopefully doing so will eventually lead to a clearer set of standards that solar PPA developer can follow to avoid a complete wipe out during a host facility foreclosure.

About The Authors

Brandon Conard is the CEO/General Counsel of Greenzu, specializing in financing commercial solar PPAs and solar leases. His expertise includes commercial energy analysis, solar fund structuring, and project finance. Previously, he led BlueMap’s energy research and engineering team providing advanced clean-tech purchase analytics to large commercial properties. As former Weil, Gotshal, & Manges attorney, Mr. Conard also understands the changing energy, tax, securities, construction, and environmental hurdles every solar project must clear. He’d love feedback on this article. Send it to info@greenzu.com.

Matt Kenefick s an attorney at the firm of Jeffer Mangels Butler and Mitchell LLP, whose practice area includes real property and insolvency matters. Send him questions at msk@jmbm.com.

Solar power purchase agreements (PPA) steal a page from the cell phone playbook.

In a PPA, the project developer pays to install the solar and, in exchange, the host facility’s owner agrees to buy the solar energy for the next 15 to 20 years. Companies like SunEdison and SolarCity are successfully using this brilliant approach to line up residential customers and large facility customers. The problem is virtually no one offers PPAs to the millions of small-to-medium size businesses in America. Why? Transaction costs. They eat up all the savings on small systems.

Making solar PPAs available to small businesses requires understanding what currently drives these transaction costs, and then developing a new deal structure geared specifically to avoid those costs. When a business like a car dealership, small hotel, or 100-person office wants solar, they are typically looking for a 10kW to 20kW system. Right now, most PPA providers will not touch a commercial project under 40kW. The reason is the transaction cost for a 10kW PPA is the same as for a 100kW system. Often the costs are so high that they cannot beat utility prices on systems under 40kW.

Current PPA Transaction Cost Drivers

After examining these deals closely, Greenzu found three components of the deal structure significantly drove up transaction costs by consuming time through negotiations, lawyers fees, and expensive auditors. The good news is, we have developed a solution that can avoid these issues. But first, the three transaction cost drivers at issue are:

1. Negotiating Price

Logically, the central point of negotiation is what price the host facility will pay for electricity. In addition to the initial price per kWh, PPA providers push for an “escalation rate,” i.e., the rate energy will go up each year, arguably as close to the amount utilities’ rates will rise. As a result, before agreeing to an escalation rate, many hours are spent on both sides haggling over what utility rate inflation will be over the next 20 years.

2. Negotiating Allocation of Risk

PPA providers usually are backed by an outside investor. The investor wants to push as much equitable risk as possible to the building owner. Many owners have not installed solar before, so they push back on taking responsibility for risks they do not understand. That means issues like indemnification, force majeur, and liability for system downtime are heavily negotiated.

3. Due Diligence

At current prices, solar installations take about 10 years to break even, meaning that the PPA provider’s profit comes entirely from the last half of contract term. In such a scenario, PPA investors require extensive due diligence to assess whether it is safe to expect the building owner to be in business 20 years from now. After all, these days even GM is not a safe bet. The financial due diligence is expensive. In addition, the high credit standards imposed weed out a huge percentage of interested building owners.

A Three-Part Solution To Transaction Cost

After working with dozens of mid-size businesses to line up small-scale PPAs, Greenzu found the transaction cost drivers above could be eliminated by restructuring the deal as follows:

1. Take-It-Or-Leave-It Contract Where Seller Takes the Risk

Stop wasting time negotiating risk allocation. Banks will not negotiate with you on small loans. The PPA provider should do the same. If the building owner wants a different contract provision, tell him to find a different PPA provider (hint: at 10kW, there aren’t any). However, to stop owners from simply walking away every time, allocate most equitable risks to the seller. The seller is more knowledgeable, more able to respond to problems, and likely to receive greater benefits from the deal. The one exception is damage caused by the buyer’s intentional or negligent conduct. Again, think of the cell-phone contract: if you break the phone, you pay. If anything else goes wrong, the service provider takes care of it.

2. Index Pricing

Stop trying to convince building owners they’ll save money with your escalation rate. Put your money where your mouth is by using index pricing. Simply price the solar electricity at five percent less than whatever the equivalent utility rate would be at that moment. Sure, investors will balk since this makes projected revenue an unknown. However, every solar sales rep claims utility rate escalation is inevitable. If true, then index pricing turns that escalation into a windfall of profits for the investor.

3. Plug and Play Solar

Stop assuming each solar install must be custom designed. The due diligence on each deal is so extensive because PPA providers assume the investment in solar installation is lost entirely if the host facility goes under before breaking even. This is a valid assumption when each system is custom designed. A standardized system, however, could be quickly removed and redeployed. By cost-effectively redeploying a “plug & play” solar system at another facility, we radically diminish the risk of loss from the fist facility closing. In that scenario, the financial stability requirements can be lowered. As a result, the due diligence inquiry can go from the expensive third-party audit to a simple credit check akin to what banks undertake for a small business loan. The bonus here is that with reduced financial stability requirements, millions of additional businesses become viable PPA targets.

Challenges to the Three-Part Solution

Admittedly, this three-part plan is a bit of a wish list. Currently, we see at least three challenges that emerging companies could address to help make this plan a reality. First, the long-term efficacy of plug and play systems like Solyndra’s is unproven. Second, index pricing is easier said than done. When a few large PPAs tried it, they found it more challenging to implement than expected. Third, it will take an enlightened investor to sign off on a deal akin to the one described above. The current returns on PPA deals are so thin that installers try to force heavy-handed contracts onto building owners just to get the investor to sign off. A savvy investor, however, can use our proposed approach to reduce risk while blowing open the market for PPAs, thereby capturing the upside of a higher deal volume.

We’d love to hear from anyone who knows of vendors with plug and play installs or index-pricing technology. Feedback from potential PPA investors is also most welcome.

About The Author

Brandon Conard is the CEO/General Counsel of Greenzu, specializing in financing commercial solar PPAs and solar leases. His expertise includes commercial energy analysis, solar fund structuring, and project finance. Previously, he led BlueMap’s energy research and engineering team providing advanced clean-tech purchase analytics to large commercial properties. As former Weil, Gotshal, & Manges attorney, Mr. Conard also understands the changing energy, tax, securities, construction, and environmental hurdles every solar project must clear. He’d love feedback on this article. Send it to info@greenzu.com.

Companies paying over $200,000 in income tax can turn their tax bill into a profitable short-term investment by becoming a “Tax Equity Investor” in a solar project. Large companies, like Google, have long been able to make tax credit investments. Meanwhile, mid-size companies were kept out because the deal exceeded their tax appetite. Now, that has changed thanks to the proliferation of firms like Greenzu developing tax-advantaged solar projects which demand corporate Tax Equity Investors of all sizes. The trick is figuring out if your company is an eligible investor, and if so, which solar projects are good investments. Below are a few important guidelines.

A. Corporate Tax Equity Investing In A Nutshell

A race is afoot to install solar on as much flat commercial roof space as possible using a financing mechanism called a Power Purchase Agreement (PPA). In a PPA, developers like Greenzu install solar on a building’s rooftop at no cost to the building owner. The building owner, in turn, agrees to pay the developer for all the solar electricity generated over the next 20 years. In other words, the solar developer becomes a utility company. It owns the generating assets and gets repaid over time for the sale of energy. In addition, as the system owner, the solar developer is entitled to take all the tax incentives offered to people who go solar.

When you install a solar electricity system on a commercial rooftop, over 50% of the installation cost is repaid immediately through federal tax incentives. Unfortunately, many solar project developers lack the tax appetite to utilize those tax incentives. As a result, they form a joint venture with a company that has a large enough tax bill to use the tax credits.

The way the joint venture works is the corporate partner buys an ownership stake in the solar project for an amount equivalent to the after tax value of the tax incentives, hence the name Tax Equity Investor. In return the Tax Equity Investor receives essentially all the tax credits and deductions given to the solar system, plus a share of the project cash flows. The Tax Equity Investor can expect returns between 12% to 15% over 5 years, with a 100% return of capital in the first year via tax bill reductions.

B. Which Companies Are Eligible Tax Investors?

The IRS limits which businesses can be Tax Equity Investors through the “Passive Activity Limitations.” (PAL) (See Instructions for Form 8810, and IRS Publication 925). If PAL applies, it may limit the amount of tax credits and deductions the Tax Equity Investor could take in a single year, thus diminishing the investment’s rate of return. The PAL rules apply differently based on the taxpayer’s entity type. Individuals and Pass-Through Entities are subject to the full force of PAL. Closely Held C-Corps face a watered-down version of PAL. Widely-held C-Corps are not subject to it.

1. Primer: What Is A Passive Activity?

A Passive Activity is any business for which the taxpayer claims a deduction but the taxpayer does not “materially participate” in the business. Naturally, the IRS test for “material participation” is complex but as a good rule of thumb it requires engaging in over 500 hours of day-to-day management of the business over the year. (See IRS §465(c)(7)(C) for further exceptions.) Tax Equity Investors traditionally do not materially participate in the day-to-day management of the solar project, therefore it may count as a Passive Activity. In that case, the Passive Activity Limitations may apply. The rules work differently based on the business’ entity type. The following sections walk-through how PAL works for each type of entity.

2.    Pass-Through Entities (S-Corp, LLC, Partnerships, etc.)

As a LLC, Partnership, S-Corp, your business taxable gain or loss is passed through to the owners’ personal income tax return. Therefore, the PAL rules applying to individuals governs your business investment as well. For individuals, the crux of the Passive Activity Limitation says losses from passive activities can only be deducted against taxable income generated by passive activities. (IRS Pub. 925 pg 2). In other words: you cannot deduct losses generated by passive activities against income generated from non-passive business activities, such as the salary from your job. If you do not have sufficient passive income to offset the entire deduction, you carry the remaining deduction forward to offset against future passive income or until you sell your interest in the activity.

To illustrate how this works let’s walk through an example using a law firm set up as an LLP (also a pass-through entity). Bear in mind – the money made from core business activities is considered non-passive income. For the law firm the income generated by providing legal services will be non-passive income to the law firm partners (assuming they practice in the firm). In contrast, if the law firm also rents out an old building that rental income will be passive income. PAL says the law firm owners cannot use deductions from the rental business to offset income generated by the law firm’s legal services. Also note that any money made from investing in public stocks or bonds does not count as Passive Income. The IRS refers to that as Portfolio Income, and says it is not included in the calculation of Passive Income.

3.    Closely Held C-Corporations

The Passive Activity rules impose less of a limitation on Closely Held C-Corps. A closely held corporation can deduct passive activity losses against all active income except portfolio income. The IRS provides the following definition: “Closely held corporation. A corporation is a closely held corporation if at any time during the last half of the tax year more than 50% in value of its outstanding stock is directly or indirectly owned, by or for not more than five individuals, and the corporation is not a personal service corporation.” Instructions for Form 8810 (2011) pg 1.

Typically, Closely-Held C-Corporations investing in solar projects will not be hindered by PAL because they earn the bulk of their taxable income through core activities, not portfolio income. Even if the solar tax equity investment is deemed a passive activity, the closely-held corporation can use the solar tax incentives to offset the core taxable income. Only income earned from stocks, bonds, and other similar “Portfolio Income” will be restricted from offset by PAL. For most companies, this means PAL will not diminish the tax equity investment returns.

4.     Widely Help Corporations

Any widely held corporation is free to invest in solar projects without fear of limitation by the Passive Activity rules. The Passive Activity Limitation is expressly limited to Individuals, Pass-Through Entities, and Closely Held Corporations. The IRS does not provide a definition of “Widely Held Corporation.” However, by PAL’s definition, any for profit C-Corp that does meet the Closely Held Corporation definition is not subject to the rule’s restrictions.

C. Risks To Solar Tax Equity Investments

Tax Equity Investors frequently begin by asking “What are the risks?” The answer depends on how the deal is structured. However, one risk is common to all deals: Recapture Risk. Below is a quick explanation of what this is, and a few notes on how to evaluate its impact.

The IRS requires the solar system remain in use for 5 years, otherwise a pro-rata amount of the tax credit may be recaptured. (See Instructions for Form 3468 pg 1.) For example, if the tax credit was $100,000, and the solar system was permanently taken out of service in year 4, then $20,000 (plus fees) must be paid back to the IRS. If the same system was taken out of service in year 6, then no money would be owed to the IRS because the recapture period had expired.

In most scenarios, the recapture risk is minimal with rooftop solar systems. Underwriting will identify buildings that can stay in operation for at least 5 years through the recapture period. However, if a customer goes into default, the solar system can stay on the roof. Often foreclosing banks or new building owners continue to use the solar power. Even if they do not, the power can often be sold back to the utility instead of the customer. In the eyes of the IRS, that satisfies the continued operation requirements meaning no recapture is required.

About The Author

Brandon Conard is the CEO/General Counsel of Greenzu, specializing in financing commercial solar PPAs and solar leases. His expertise includes commercial energy analysis, solar fund structuring, and project finance. Previously, he led BlueMap’s energy research and engineering team providing advanced clean-tech purchase analytics to large commercial properties. As former Weil, Gotshal, & Manges attorney, Mr. Conard also understands the changing energy, tax, securities, construction, and environmental hurdles every solar project must clear. He’d love feedback on this article. Send it to info@greenzu.com.

Companies large and small are beginning to invest in solar tax credit deals as a smart tax strategy. Although these investments are smart and relatively straightforward, Greenzu’s team finds itself frequently educating new tax equity investors on a few key deal points. These are not tips in how to structure your investment, but rather how the underlying solar project deal with the customer should be structured.

Basic Solar Project Deal Structure

Most commercial solar projects are financed using a Power Purchase Agreement (PPA) or a Solar Service Agreement which is similar. In a PPA, developers like Greenzu install solar on a building’s rooftop at no cost to the building owner. The building owner, in turn, agrees to pay the developer for all the solar electricity generated over the next 20 years. At the end of the 20 years, the developer either removes the system or the building owner buys it for a residual buyout price. The developer retains ownership of the solar system throughout the term of the PPA. As the system owner, the solar developer is entitled to take all the tax incentives offered to people who go solar.

When you install a solar electricity system on a commercial rooftop, over 50% of the installation cost is repaid immediately through federal tax incentives. Unfortunately, many solar project developers lack the tax appetite to utilize those tax incentives. As a result, they form a joint venture with a company that has a large enough tax bill to use the tax credits. The way the joint venture works is the corporate partner buys an ownership stake in the solar project for an amount equivalent to the after tax value of the tax incentives, hence the name Tax Equity Investor. In return the Tax Equity Investor receives essentially all the tax credits and deductions given to the solar system, plus a share of the project cash flows.

Two Issues Worth The Tax Equity Investor’s Attention

Companies considering making a tax equity investment should evaluate the deal structure to confirm their tax incentives are safe. There are two common mistakes solar project developers can make when setting up the deal that put the tax incentives at risk: (1) Leasing to a Non-Profit; and (2) Fixing a Buyout Price. Fortunately, both are easy to spot before making the investment. Even better, the solution for both is explained in safe harbor rulings from the IRS.

Mistake 1: “Leasing” To A Non-Profit

A solar system that is sold or leased to a non-profit loses its federal tax incentives. Tax credits go to the solar system owner. If the owner is a non-profit, then the system is not eligible for the Federal Investment Tax Credit (ITC). (Instructions Form 3468) Similarly, equipment “leased” to a non-profit is not eligible for the ITC essentially because the IRS views the non-profit as the system owner. See IRS §7701(e).

A solar project installed on a non-profit rooftop can keep the tax incentives if the deal is a Power Purchase Agreement instead of a lease. Section 7701 outlines the criteria that makes one agreement a lease and another a PPA. Regardless of what you name the agreement, if you do not meet the Section 7701 criteria the IRS will disregard call it a lease to a non-profit, which is thereby ineligible for the Investment Tax Credit. Fortunately, the standard PPA deal structure naturally follows the Section 7701 criteria. Nevertheless, Greenzu often sees creative project developers propose two terms in particular that would run afoul of Section 7701, meaning the PPA to a non-profit would be deemed a lease. To avoid these two traps:

1. Avoid fixed payments. If the non-profit customer pays a fixed amount each month, the project is a lease. If the amount owed varies each month based on energy production, then it is a service contract or power purchase agreement.
2. Avoiding shifting maintenance to the customer. If the non-profit customer is required to maintain the solar system (or pay for normal maintenance), then the IRS says it is a lease because the lessor bears no risk for equipment failure, which makes it closer to a sale than a service. If the project owner pays for normal maintenance, it is closer to a PPA or Service Agreement.

Mistake 2: Fixed Buyout Price

The PPA should not promise the customer a sweetheart buyout price at the end of the PPA term. If you do, the IRS may treat it as a sale and say the tax credits go to the building owner not the Tax Equity Investor. Keep in mind, there is strong pressure to ignore this advice. Before they sign the PPA, customers will press to fix a buyout price as low as possible. Before making the investment, many investors will want to add a fixed buyout price into their investment model. Yet, all parties (developer, customer, and investor) must overcome this temptation. Any PPA that promises a fixed buyout price below fair market value may end up sending the Federal Tax Incentives to the customer and not the Tax Equity Investor.

As previously mentioned, the tax incentives go to the owner of the system. The IRS has the power to ignore the “form” of a contract and look at its true economic substance. If the IRS decides a PPA is in reality a sale, it will say the tax incentives go to the customer not the project developer/investor. The IRS issued a safe harbor ruling blessing certain PPA deal structures. (See Revenue Procedure 2007-65.) One requirement in the safe harbor involved the end-of-term buyout price. The IRS said the PPA cannot promise to sell the equipment for less than Fair Market Value (FMV).

The solution is to set the buyout price to “the greater of FMV or” a fixed amount. The economic reality is that before signing a PPA, customers want some idea what ballpark the buyout price will fall in. The Fair Market Value concept provides no clarity since the system will be 20 years old at that time. Yet, the IRS and your customer are judging this provision based on what your PPA says on Day 1. Therefore, to satisfy the IRS while also giving the customer some insight into your thinking, you can split the baby and say: the buyout price will be “the greater of Fair Market Value or a Fixed Price.” You then can include a declining buyout schedule in the PPA. If the IRS questions it, you can show the FMV price sets the floor, so you have met the safe harbor requirement.

About The Author

Brandon Conard is the CEO/General Counsel of Greenzu, specializing in financing commercial solar PPAs and solar leases. His expertise includes commercial energy analysis, solar fund structuring, and project finance. Previously, he led BlueMap’s energy research and engineering team providing advanced clean-tech purchase analytics to large commercial properties. As former Weil, Gotshal, & Manges attorney, Mr. Conard also understands the changing energy, tax, securities, construction, and environmental hurdles every solar project must clear. He’d love feedback on this article. Send it to info@greenzu.com.

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