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Presenting a live 90-minute webinar with interactive Q&A

Solar Energy Projects:

Structuring EPC Agreements Navigating Contract Structure Issues, Unique Issues in

Solar PV EPCs, Performance Guarantees and Defect Warranties

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, NOVEMBER 24, 2015

Drew Baldinger, Partner, DLA Piper, Houston

Stephen J. Humes, Partner, Holland & Knight, New York

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Solar Energy Projects: Structuring EPC Agreements

November 24, 2015

DREW BALDINGER DLA Piper LLP (US)

STEPHEN J. HUMES

Holland & Knight LLP

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• Drew Baldinger has several years of experience representing developers, financial institutions, electric utilities, private equity, contractors and other investors in the development, construction, operation, acquisition, divestiture, ownership and debt and equity financing of domestic and international energy projects and companies.

• In particular, Drew has represented domestic and international developers, electric utilities and investors in connection with various aspects of solar (photovoltaic and thermal), wind and geothermal energy generation projects, conventional energy generation projects and transmission projects, in addition to gas-to-liquids projects and upstream and midstream oil and gas investments.

• Drew is a partner in the Houston office of DLA Piper LLP (US).

Drew Baldinger

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• Steve Humes practices environmental, energy, public utility and infrastructure law at Holland & Knight and advises clients on renewable energy regulatory, project finance and development issues, including environmental issues and project contracts. He represents project developers, sponsors and banks on solar PV, biomass, geothermal, and energy storage projects, among other technologies, and represents the Connecticut Green Bank and New York Green Bank along with project owners and developers from New Jersey to California and New York to Nicaragua. He also assists clients with state and federal environmental and energy regulatory compliance and enforcement matters and counsels clients on energy and environmental issues in corporate M&A transactions, including acquisitions and divestitures of fossil and renewable power plants.

• Steve is based in Holland & Knight’s New York City office.

Steve Humes

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• Introduction to Solar PV Transactions

• Power Purchase Agreement

• Owner Buys Turnkey Project

• Regulatory Considerations (Net Metering vs. Wholesale Power Project; PPAs vs. Solar Leases; Size Limits)

• Summary of Key Ancillary Agreements

• PPA/REC Offtake Agreements

• Interconnection Agreement

• Solar PV Panel Module, Racking System and Inverter Supply Agreement (if applicable)

• Real Estate Entitlements

• O&M Agreement

Overview of a Solar PV Project Transaction Structure

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State Regulatory Requirements Vary Significantly

• Distributed Generation: Project is “inside the fence” and interconnected electrically to host behind the utility meter.

• Net Metering: Revenue meter tracks electric usage both ways – when host uses less electricity than solar PV system generates, surplus flows to local electric utility – issue is who gets the credit for surplus power and for how much?

• DG Size Limits: Could be 2 MW or less; 6 MW or less; or less than host’s annual consumption needs – states allow utility’s interconnection tariff to limit size of project.

• EPC Contract: Performance contingent on Interconnection.

• Interconnection Delays: Utility-specific, contractor experience

Solar Project Regulatory Considerations: Net Metering and Interconnection Issues

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• State and Local Regulations and Compliance Obligations

• NIMBY Issues (e.g., Wind Farm or Solar Siting)

• Zoning and Permitting Requirements/Restrictions

• Access to Rights of Way

• Existing Easements/Land Use Restrictions

• Access to the Electrical Grid (Interconnection)

• Pre-existing Environmental Conditions (e.g., Brownfields, Landfills)

• Suitability of Existing Ground Conditions

• Closure Requirements/Termination Assurances (e.g., Restoration of Site)

Owner Site Acquisition Risks

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Engineering, Procurement and Construction Agreement

(EPC) – the design-build contract between Project Owner (“Owner”) and General Contractor (“Contractor”)

• Types of EPC Agreements – Contract Structure

• Wrap vs. No Wrap

• General Overview on Interplay with Other Agreements

• Supports PPA Performance and Schedule Obligations

• Often Relies on Supply Chain Agreements

• Modules

• Inverters

• Racking Systems

• Often Links Performance Guarantees with O&M Agreement

EPC Agreement Defined

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IT’S ALL ABOUT RISK ALLOCATION…

• CONSTRUCTION

• Price Risk

• Permitting Risk

• Performance Risk

• Schedule Risk

• EXCEPTIONS

• OTHER FINANCING ISSUES

Solar EPC Risk Allocation

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• General:

• It is unlikely that a sophisticated offtaker will agree to pay for construction cost overruns through an increase in PPA pricing.

• Non-recourse construction financings are sized based on PPA pricing, PPA term and offtaker creditworthiness, with a small contingency to cover construction cost overruns, among other things.

• Accordingly, lenders will not generally take construction cost risk, and therefore require that the EPC Agreement be fixed-price, with only limited, customary exclusions that permit price increases.

• Payment Mechanics:

• Milestones vs. Schedule of Values

• Invoice approval process

• Lien waivers

• Right to dispute in good faith

Price Risk

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• Exceptions:

• Equity assumes risk that delays in issuing the Full Notice to Proceed (“FNTP”) will result in price increases.

• Negotiate a sufficient time period between execution of EPC Agreement and the initial drawdown of the construction financing.

• Negotiate specified price increases for a limited period.

• Scope of Work

• Wrapped vs. Unwrapped Risk

• Owner-Supplied Equipment, Other Owner Obligations and Owner-Issued Change Orders

• Permits and Real Property Rights

• Interconnection Provider

• Contractor-Issued Change Orders

• Other Negotiated Exclusions

Price Risk (Con’t)

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Permitting Risk

Permits

• Land use, zoning

• Building Permits

• Federal and State Authorizations

• Environmental • Brownfields

• Closed Landfills

• Open Landfills – Solar built into cap/remediation design

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• What is the timeline for issuing permits?

• Do all timelines match those of leases, PPAs and loan documents?

• Are public hearings required?

• Are hearings necessary to gain public support?

• Who is responsible for obtaining permits?

• Project Permits are obtained in Owner’s name, but Contractor typically applies for and pursues applicable permits (with Owner’s cooperation).

• Since Project Permits typically contain conditions to construction, Contractor should be directly responsible for satisfying permit conditions.

• Contractor responsible for permits applicable to Contractor’s tools, equipment, personnel and operations.

Permitting Risk (Con’t)

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• Will equipment and/or technology fail?

• Is the site suitable for construction and operation of the facility?

• Will EPC contractor fail to complete construction?

Performance Risk

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TOOLS TO MANAGE RISK:

• Who has Permitting Responsibilities? (Deadlines, Cooperation, Effects of Delay)

• Liquidated damages for performance

• E&O/Environmental Insurance

• Construction/Stop Loss Insurance (controls cost overruns from unexpected conditions)

• Credit Support

• Owner Controlled Insurance Program (OCIP)

• Environmental Surveys

• Geotechnical Studies and Surveys

• Warranties

Performance Risk (Con’t)

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Will the Project Be Completed on Time and within Budget?

• Project development risk is partially allocated to EPC contractor and insurers – EPC contractor should contractually assume PPA’s COD and related delivery obligations (performance guaranty, minimum system size, etc.)

• LDs for Failure to achieve

• Warranties (linkage to O&M Agreement)

• Conditions Precedent: Interconnection

• Zoning and Land Use Approvals

Performance Risk (Con’t)

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• Capacity Guaranty:

• Minimum Guarantied Capacity

• Achievement of the minimum guarantied capacity is a condition to substantial completion, resulting in delay liquidated damages if such minimum guarantied capacity is not timely achieved

• Minimum guarantied capacity supports PPA capacity requirements

• Guarantied Capacity

• Failure to achieve the guarantied capacity results in performance liquidated damages, supporting lost revenue and a buydown of debt

• Cure Period

• Period

• Cooperation

• True-Up Payment

Performance Risk (Con’t)

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• Adjusted Energy Performance Test:

• Generally a long-term test (365 days) that occurs multiple times (1-5) after substantial completion, comparing actual energy performance to expected energy performance.

• Performance Liquidated Damages

• Module warranties last longer, but remedy is generally repair, replacement or supplemental panels.

• Adjustments are required to remove weather and operational effects, including for soiling, temperature, force majeure and irradiance.

• Risk of monitoring equipment inaccuracies increases.

• Redundancies

• Calibration requirements

Performance Risk (Con’t)

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• General: • A sophisticated offtaker will impose an outside date by which the

facility must be constructed, enforced through payment of delay liquidated damages and eventually resulting in termination of the offtake agreement.

• The lenders are primarily concerned with a delay in construction resulting in the PPA being terminated (and potentially lost tax consequences, when applicable).

• Owner is incurring delay damages, interest during construction and other fixed costs in the event of a construction delay, and is also foregoing revenue from the sale of power.

• Accordingly, Owner requires guarantied milestone date(s) from Contractor, as well as other provisions to mitigate construction schedule risk or otherwise share construction schedule risk with Contractor.

Schedule Risk

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• Guarantied Milestones: The Parties will negotiate guarantied substantial completion dates for blocks of PV panels (in larger projects) and/or an overall substantial completion date. • If Contractor fails to achieve any guarantied milestone date, Contractor

will pay, as Owner’s sole remedy, a daily amount constituting liquidated damages until such milestone is achieved. • Sizing delay liquidated damages • Costs (in terms of money and schedule) • Limitations on Liability/Performance Excuses • Delay-In-Startup Insurance

• Termination: If Contractor is too delayed, Owner may want the right to: • declare a default and terminate the EPC Agreement upon Contractor

missing an outside date; or • prospectively declare a default and terminate the EPC Agreement if

Contractor could reasonably be expected to miss an outside date.

Schedule Risk (Con’t)

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• Bonus: Owner may consider offering a bonus for early block substantial completion or overall substantial completion.

• Calculation and Limitations

• Negotiation Strategy

• Acceleration: Owner usually has the right to issue a change order accelerating performance under the EPC Agreement.

• Subcontractor Limitations: The EPC Agreement often specifies permitted material subcontractors and requires Owner’s consent to change material subcontractors.

• Other Mitigation: Diligence of Contractor, management team and labor supply, progress reporting, PPA, others.

Schedule Risk (Con’t)

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• Credit Risk

• Limitations on Liability

• Change Order and Force Majeure Provisions

• Tax Issues

• Assignment

• Dispute Resolution and Governing Law

Issues Affecting Owner’s Risk

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• General:

• From a practical standpoint, the value of a contract is based both on the terms of the contract, and the ability of the parties to perform the terms of the contract.

• Lenders want an entity with an investment grade rating from Moody’s and/or S&P to guarantee the timely construction and performance of the project for a fixed-price in accordance with the EPC Agreement.

• Also secures other obligations of Contractor under the EPC Agreement, including warranty obligations

• Contractor provides the primary warranty, and subcontractor credit risk may arise after the expiration of that primary warranty

• Contractor wants to secure Owner’s timely payment of the contract price (to primarily protect profit margin and payments to third parties).

Credit Risk

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• General: If Contractor as counterparty to the EPC Agreement is not itself creditworthy, credit support will be required.

• Forms of Credit Support: Contractor’s credit support is provided in one or more of the following forms:

• Payment and Performance Guaranty

• Payment and Performance Bond

• Retention (regardless of Contractor’s creditworthiness)

• Other rights of Owner to withhold payment in defined circumstances from invoiced amounts under the EPC Agreement

• Insurance (regardless of Contractor’s creditworthiness)

Contractor Credit Support

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• General: In a non-recourse financing, Contractor will generally mitigate its concerns regarding Owner’s ability to pay the contract price by:

• Conditioning FNTP upon the initial drawdown of the construction financing; and

• Structuring the milestone payment schedule to include an upfront down payment at FNTP, as well as “front-weighted” milestones that keep Contractor ahead of its expected costs.

• Flow through termination provisions in subcontracts

• Owner will be concerned with ROI for “front-weighted” payments

• Other Protections: (1) Suspension rights for failure to pay, (2) limitation on Owner-Issued Change Orders, and (3) mechanics’ liens.

Owner Credit Support

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• General: A separate payment and performance guaranty is executed by a parent or affiliated company of Contractor simultaneously with the signing of the EPC Agreement.

• Basic Obligation: Guarantor unconditionally, absolutely and irrevocably guarantees the full and timely payment of all amounts when due, and performance when due, by Contractor under the EPC Agreement.

• Limitations:

• In addition to “joint efforts” drafting clauses, a guaranty will contain a number of defense waivers.

• Guarantor reserves any right, counterclaim and defense of Contractor with respect to the guarantied obligations, other than specified defenses.

• Monetary and Temporal Limitations and Exceptions

• Governing Law: New York

Guaranty

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• General: A percentage of each payment is withheld by Owner as performance security for Contractor’s obligations under the EPC Agreement or a letter of credit is issued in lieu thereof.

• Release:

• Most of the retainage is released at substantial completion.

• Except for amounts needed to complete punchlist items

• Occasionally, a minimum amount is maintained until final completion

• Post-substantial completion retainage is generally released as punchlist items are completed, with the remainder released as of final completion.

• Except for amounts spent by Owner to complete punchlist items

• Occasionally, a minimum amount is maintained through the general warranty period

Retainage

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• Easy execution and provides liquidity

• Issued by a financial institution that is sufficiently qualified

• Irrevocable for a period of time, but may be automatically renewed

• Form of demand typically attached

• Draw Conditions

Letter of Credit

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• General: Contractor’s return on investment is not substantial and thus, Contractor is generally not willing to expose its organization to unlimited risk for one project, in particular in a fixed-price contract with schedule and performance guaranties that are supported by a creditworthy parent.

• Caps on Liability: • Delay Liquidated Damages • Performance Liquidated Damages • Overall Liquidated Damages • Overall Limitation on Liability

• Before vs. After Substantial Completion • Exceptions

• Third-party claims indemnifiable under the EPC Agreement • Gross Negligence/Willful Misconduct/Intentional Fraud • Title • Insurance

Limitations on Liability

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• Other Waivers:

• Warranties: Contractor waives all representations and warranties that are not expressly provided in the EPC Agreement.

• Exclusive Remedies:

• Remedies expressly set forth in the EPC Agreement

• Missing guarantied schedule milestones

• Missing performance guaranties

• Consequential Damages: Each Party waives any right to claim consequential damages under the EPC Agreement.

• Third-party claims indemnifiable under the EPC Agreement

• Gross Negligence/Willful Misconduct/Intentional Fraud

• Liquidated Damages/Termination Payments

• Others

Limitations on Liability (Con’t)

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• General: Each Party has certain rights to demand a change in the terms of the EPC Agreement. This includes Contractor’s rights to receive additional time and money based on the occurrence of specified events (but generally not modifications to other terms of the EPC agreement).

• Events:

• Force Majeure

• Owner-Cause Delay

• Change in Law

• Subsurface Issues

• Changes in Work Required by Owner

• Suspension

Change Orders

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• Mechanics: Owner often negotiates for procedural requirements that, if not strictly followed for a specified event, will result in Contractor losing its rights to a change order for that event.

• Thresholds: Owner often negotiates for materiality qualifiers or dollar thresholds that must be exceeded before Contractor is entitled to a change order for money.

• Schedule: Owner often negotiates so that Contractor is permitted a change order for time only if the applicable event affects the critical path and exceeds a threshold of days.

• Other Requirements and Considerations: (1) Mitigation, (2) Over-Head Allowances, (3) PPA, (4) Lump-Sum Pricing and (5) Other.

Change Order Limitations

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• Definition: Force Majeure generally means any circumstance not within the reasonable control of the claiming Party, but only if (a) such event is not due to such Party’s negligence or willful misconduct and is not due to such Party’s failure to perform any of its obligations under the EPC Agreement; (b) such Party could not have reasonably avoided such event and has taken commercially reasonable efforts to mitigate and eliminate the effects of such event; and (c) such Party has provided the other Party with notice thereof within three (3) days after such event has occurred.

• Examples: If the definition is satisfied: war, riot, sabotage, acts of public enemy, terrorist acts, severe and unusual weather, flooding, explosions, fire arising from natural causes, earth quake, hurricanes, tornados, forest fires and hailstorms.

Force Majeure

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• Exclusions: The following are typically excluded:

• Changes in interest rates, inflation rates, insurance premiums, commodity prices, exchange rates, availability of financing or other general economic conditions;

• Changes in financial condition of Owner or Contractor;

• Any strike, lockout or other labor dispute of Contractor or its subcontractors that are not regional or national;

• Equipment or labor pricing increases or labor unavailability; and

• Subcontractor’s failure to perform, mechanical failure of equipment or delays in receiving equipment or materials, in each case, to the extent not resulting from a specified Force Majeure.

• Termination: Owner often has the right to terminate for extended Force Majeure claimed by Contractor.

Force Majeure (Con’t)

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• Role of Federal Investment Tax Credit and Section 1603 Safe Harbor Panels (Good until December 31, 2016)

• Tax Incentives Expiring Soon unless Congress Extends – possible year-end tax extender package could include ITC

• “Placed in Service” Issues – Don’t throw the switch on until Owner is Ready

• Tax Equity Investor does not want EPC Risk so Tax Equity Investor will typically not accept project ownership until Substantial Completion or just prior to “Placed In Service”

• State Tax Incentives and Grants

• Understand Documentation Required to Show Completion and Project Costs

• Accountants must certify to Treasury Qualifying Cost of Project

EPC Agreement and Tax Issues

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• Assignability: Assignment is generally subject to consent.

• Collateral assignment is required for a non-recourse financing.

• Assignment to an affiliate is generally acceptable if credit support remains or is provided and such affiliation continues.

• Assignment by Owner to successor to project is generally permissible in a non-recourse financing.

• Change of control is usually not restricted.

• Breach of assignment restrictions causes assignment to be void.

Other EPC Agreement Issues

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• Dispute Resolution

• Arbitration, Expert Determination or Court of Law

• If Arbitration, consider:

• Number of arbitrators

• Location

• Sharing of Costs

• Final and Binding

• Permitting injunctions/interim court relief

• Consider including officer escalation process

• Choice of Law

• Owner typically specifies governing law.

• Contractor may have objections based on familiarity/limits on liability.

Other EPC Agreement Issues (Con’t)

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• Cooperation by Contractor/Guarantor with Lenders:

• Direct Agreement/Consent to Collateral Assignment

• Legal Opinion

• Officer’s Certificate

• Financial and Other Information

• Independent Engineer

• Liens:

• Conditional and Unconditional Mechanic’s Lien Waivers

• Subordination of Mechanic’s Lien

• Cure/Reimbursement/Indemnification

• Third-Party Beneficiaries

Other Financing Issues

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• Termination Rights: Contractor should have limited rights to terminate the EPC Agreement after FNTP.

• Default vs. Change Order

• Suspension

• Extended Force Majeure

• Insurance:

• Coverage

• Additional Insurance

• Subrogation

• Notice of Termination

• Payment of Proceeds

Other Financing Issues (Con’t)

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• Others:

• Setoff: Lenders generally do not like Contractor to have setoff rights against amounts owed by Contractor to Owner.

• Title: Title should pass at the earlier of payment and delivery to the site.

• Risk of Loss:

• Before Substantial Completion

• After Substantial Completion

• Indemnities: Contractor should indemnify Owner for appropriate third-party claims.

• Intellectual Property

• Breach of Law

• Taxes

Other Financing Issues (Con’t)

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DREW BALDINGER STEPHEN J. HUMES

DLA Piper LLP (US) Holland & Knight 1000 Louisiana, Suite 2800 31 West 52nd Street Houston, Texas 77002 New York, New York 10019 (713) 425-8453 (212) 513-3473

Email: drew.baldinger@dlapiper.com Email: steve.humes@hklaw.com

Website: www.dlapiper.com Website: www.hklaw.com

Thank You

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