Structuring Engineering, Procurement and Construction...

EPC Agreements in Solar Energy Projects Structuring Engineering, Procurement and Construction Agreements

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WEDNESDAY, MAY 16, 2012

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

Kevin J. Moore, Member, Sills Cummis & Gross, Princeton, N.J.

Philip DeHart, The Butler Firm, Austin, Texas

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EPC Agreements in Solar Energy Projects

Kevin J. Moore, Esq. Sills Cummis & Gross P.C. Princeton: (609) 227-4620 Newark: (973) 643-5251 [email protected]

May 16, 2012

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Section I: Overall Market Conditions/Recent Developments

North Eastern United States

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Overall Market Conditions/Recent Developments North Eastern United States

New Jersey and Massachusetts are the only states in the northeast with a significant number, in megawatts (MW), of installed Photovoltaic (PV) Systems.

New Jersey has the second largest number, in MW, of installed PV Systems in the United States.

Massachusetts has the third largest number, in MW, of installed PV Systems in the United States.

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Both States utilize a renewable portfolio standard combined with solar renewable energy certificates (NJ) or Solar Carve-out Renewable Generation Attributes (MA), both referred to as SRECs.

Both States' programs favor smaller, behind the meter PV Systems. However, both States have grid based PV Systems.

New Jersey has utility scale grid based PV Systems, while Massachusetts currently does not.

New Jersey utility scale grid based systems are largely developed by solar developers, not public utilities (EDCs).

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In New Jersey EDCs must generate a portion of the electricity they sell to consumers each year from solar energy, called a renewable portfolio standard or RPS.

EDCs can meet their RPS by purchasing SRECs from the owners of qualified PV Systems.

The sale of SRECs is the primary revenue/profit source for NJ grid based PV Systems.

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The only other revenue/profit source for NJ grid based PV Systems is the sale of electricity to the grid at the EDC's "avoided cost of wholesale power."

"Avoided cost of wholesale power" means the average locational marginal price of energy in the EDC’s transmission zone.

Due to an oversupply of SRECs, EDCs have met their RPS for at least the next two Energy Years.

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SRECs now trade at less than $100 per SREC.

Grid based PV System owner is responsible for upgrades to EDC transmission lines.

There is a growing public and governmental hostility toward grid based utility scale PV Systems.

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In the absence of legislative intervention, no gird based utility scale PV Systems will be built in NJ for at least the next two years.

Legislative acceleration of the RPS standard is anticipated.

Some limitations on utility scale grid based PV systems are anticipated.

UTILITY SCALE SOLAR: RECENT DEVELOPMENTS & MARKET UPDATES

Philip A. DeHart THE BUTLER FIRM, PLLC

1601 Rio Grande, Ste. 331 Austin, Texas 78701

(512) 992-0349 [email protected]

www.thebutlerfirm.com

About the Presenter Philip A. DeHart Senior Associate, THE BUTLER FIRM, PLLC – a Texas law firm servicing the clean tech and renewable energy industries University of Georgia (J.D. 2006, cum laude) Pennsylvania State University (B.A., with honors) Mr. DeHart provides transactional and regulatory services to electric utilities. Having previously practiced in a boutique bankruptcy firm in Atlanta, he also counsels utility clients and developers on their rights as creditors. Mr. DeHart services clients throughout the world on their energy projects.

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Installed Capacity

The amount of utility-scale solar installed through January 2012 depends a little on who you ask (and how they define “utility scale”): • 1,324 MW per SEIA • 1,176 MW per NREL SEIA, Utility-Scale Solar Projects in the United States: Operating, Under Construction, or Under Development, www.seia.org/galleries/pdf/Major Solar Projects.pdf (Jan. 17, 2012) NREL, Utility-Scale Concentrating Solar Power and Photovoltaics Projects: A Technology and Market Overview, www.nrel.gov/docs/fy12osti/51137.pdf (Apr. 2012) (only considered projects with 5+ MW capacity)

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http://www.seia.org/galleries/pdf/Major Solar Projects.pdf�

http://www.nrel.gov/docs/fy12osti/51137.pdf�

The Technologies

• Roughly 60% of that total is PV (photovoltaics); the other 40% is CSP (concentrated solar)

• NREL projects that PV capacity will continue to outgrow CSP as new projects come online

• CSP historically uses troughs (almost all utility scale CSP uses them today); industry buzz today focuses on CSP towers

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Domestic Markets State Operating Under

Construction Under Development

Total

Arizona 112 749 2,206 3,067

California 524 3,373 14,334 18,231

Colorado 90 30 442 563

Florida 133 110 982 1,225

New Mexico 102 22 398 522

Nevada 148 120 3,187 3,455

Texas 46 60 790 896

U.S. Totals 1,324 4,608 23,656 29,588

SEIA, Utility-Scale Solar Projects in the United States: Operating, Under Construction, or Under Development, (www.seia.org/galleries/pdf/Major Solar Projects.pdf) (Jan. 17, 2012) (values in MWs)

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Domestic Markets

NREL, Photovoltaic Solar Resource of the United States, (http://www.nrel.gov/gis/images/map_pv_ national_lo-res.jpg) (Oct. 20, 2008)

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http://www.nrel.gov/gis/images/map_pv_national_lo-res.jpg�




Other Domestic & Foreign Markets

• Experiencing a lot of buzz about island projects (especially Puerto Rico)

• Opportunities for utility-scale deployment of batteries as well (assuming you can manage the price)

• Getting a reasonable amount of interest from municipalities here in Texas as they look to stimulate local job growth and reduce overhead expense

• U.S. Border Energy Forum – joint U.S. / Mexico border projects

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Obstacles • Cheap natural gas prices limit development of new

resource entities (even of gas). • Solar PV has become much cheaper but there still is a

perception that it is quite expensive among traditional utilities

• In political circles Solyndra created really bad buzz for solar • In-fighting with other renewable industries at the state

level (e.g. Texas wind vs. solar) • Unclear regulations on deployment of solar in the Texas

ERCOT system (although anticipate substantial borrowing from wind regs)

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STRUCTURES, CORE TERMS, AND SOLAR-SPECIFIC ISSUES IN EPC AGREEMENTS

(FROM THE DEVELOPER’S PERSPECTIVE)

Philip A. DeHart THE BUTLER FIRM, PLLC

1601 Rio Grande, Ste. 331 Austin, Texas 78701

(512) 992-0349 [email protected]

www.thebutlerfirm.com

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Overview of the EPC Agreement

• Building a solar farm (like any major energy project) requires designing, engineering, obtaining materials for, and construction of a facility.

• Option 1: Developer can do piecemeal contracting – Problem: Panel suppliers generally are not known for their

construction acumen. Construction contractors generally are not known for being vendors of PV panels.

– Problem: Developer will need to be very involved in arranging each of the many contracts for the project

• Option 2: Developer can have someone else do it

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The Parties • Primary Parties: Developer, Contractor • Secondary Parties: Lender, Insurer, Engineers,

Construction Subcontractors Main Goals • Provide a “one stop shop” for the Developer • Manage risks and costs

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Advantages of EPC Contracts • One point of contact for the developer • Excellent way to manage legal risks • Little need for developer to have much staff Disadvantages of EPC Contracts • Contractor may be exposed to terrific liability

(well beyond any benefit of the bargain) • Probably higher overall contract price

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Core Terms I. Single Point of Responsibility • In its classic LSTK (lump sum turn key) form, the

Contractor should be responsible for all design, engineering, procurement, construction, and commissioning activities

• Sometimes, the contract gets split: e.g. the Developer works with its chosen engineer and then has the Contractor do the rest

• WARNING! If the contractor is comprised of a group of several entities, be sure that those entities are made jointly and severally liable to the Developer in the EPC.

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Core Terms

II. Fixed Contract Price • The Contractor bears the risk of exceeding

costs. The Contractor also enjoys the benefit of any cost savings.

• The Developer should pay additional money where it (the Developer) delayed or submitted a change order.

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Core Terms III. Fixed Completion Date • The parties agree to a guaranteed completion date (either

a particular date or a fixed period after commencement of work).

• Failure to meet the guaranteed completion date exposes the Contractor to Delay Liquidation Damages (DLDs). – Liquidated damages are unenforceable if they act as a penalty – May be void for ambiguity as to method of calculation – Assess as a rate per day that reflects all costs (lost revenue plus

financing charges and insurance) • The EPC agreement also should specify limited grounds for

extending the deadline.

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Core Terms IV. Performance Guarantees • Since the Developer’s revenue will be earned by

operating the resource entity, get guarantees from the Contractor that the facility will perform as required

• Failure to meet the performance expectations exposes the Contractor to Performance Liquidated Damages (PLDs) – Calculate at net present value, less expenses, of revenue

lost over life of the facility – Really key, especially when dealing with inexperienced

contractors

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Core Terms

V. Caps on Liability • Most Contractors will not sign a contract with

unlimited liability (although it can’t hurt to try!) • Generally, the cap on liability gets negotiated to

100% of the contract price • As Developer’s counsel, do not go below 100% • Usually, there are sub-caps on the Contractor’s

PLDs and DLDs (e.g. 15% each, 25% combined)

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Core Terms V. Caps on Liability (cont.) • Generally, the EPC contract will limit or prohibit consequential

damages. • PLDs and DLDs (as lost profits) should be excluded from any such

prohibition on consequential damages • If total damages are capped anyway, most Contractors do not raise

too much of a fuss • Capping damages and barring consequential damages increases the

bankability of the project • WARNING! Caps on general liability are fine, but be sure to set forth

exceptions for bad conduct (e.g. fraud, misrepresentation, etc.)

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Core Terms

VI. Performance Security • The Contractor should provide security to protect

the Developer if the Contractor fails to comply with its obligations

• E.G. # 1: Bank guarantee for a percentage of the contract price (typically 5-15%)

• E.G. #2: Retainage (i.e. withholding a percentage of payments) (typically 5-10%)

• E.G. #3: Guarantee by a parent company

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Core Terms VII. Change Orders • The Developer needs to be able to order variations and

agree to variations proposed by the Contractor • Drafting attorney needs to establish a clear mechanism

for processing requests for variations • If the parties cannot agree in advance as to the price of

a variation, the Developer should have final say on price (subject to dispute resolution procedures)

• WARNING! Larger variations may warrant pledges of additional security. Be sure to specify in the EPC what that security should be.

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Core Terms

VIII. Cessation of Work Prior to Completion • Sometimes work must be stopped before

completion of the project • SCENARIO 1: Force Majeure events • SCENARIO 2: Suspension • SCENARIO 3: Termination

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Core Terms VIII. Cessation of Work Prior to Completion (cont.) A. Force Majeure Events

• Force majeure events are “superior forces” (e.g. classic “acts of God”) that render performance—temporarily or permanently—impossible

• The force majeure clause generally should be drafted with two parts: (1) a categorization of events (the “laundry list”) and (2) directions as to how to handle categorical situations

• In categorizing possible force majeure events, determine which risks are (1) within the control of the Developer, (2) within the control of the Contractor, and (3) are not within the control of either party. Flag all risks outside the control of either party.

• REMEMBER! Parties should not be able to claim force majeure if they are relying on their own acts or omissions

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Core Terms

VIII. Cessation of Work Prior to Completion (cont.) A. Force Majeure Events (cont.)

• Generally, although force majeure events may excuse performance, the Developer should require:

– That the parties each bear their own costs (Contractors typically still try to request their costs)

– That the Contractor, at its sole expense, will use best efforts to avoid and minimize delay from any force majeure event

– That the burden of proof on claiming a force majeure is with the party asserting the defense

– That the Contractor will give regular (and frequent) updates upon the occurrence of any force majeure event

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Core Terms

VIII. Cessation of Work Prior to Completion (cont.) B. Suspension

• The Developer typically has a broad right to suspend work temporarily

• The Contractor only should be allowed to suspend work in the event of a default by the Developer in making payments under the EPC contract.

– The contract should have some sort of grace period for the Developer to cure any default

– The Contractor’s right to suspend for non-payment should be limited to situations where there is no reasonable dispute as to the amount in default

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Core Terms

VIII. Cessation of Work Prior to Completion (cont.) C. Termination

• The Contractor should have very limited rights to terminate: (1) for non-payment, (2) for prolonged suspension, and (3) prolonged force majeure events.

• The Developer should be able to terminate for a broader number of reasons: (1) for major breaches, (2) for unresolved lesser breaches (after some cure period), and (3) for contractor insolvency.

• WARNING! The financing agreements with the lenders may further limit the Developer’s ability to terminate. Look to the contract!

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Core Terms

IX. Performance Specifications • The EPC contract typically has performance

specifications that the Contractor must achieve.

• The “what” is determined by contract; the “how” is left to the Contractor

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Core Terms

X. O & M Manuals • The Contractor usually must prepare a fairly

detailed operation & maintenance (O & M) manual as to start-up, operations, emergency conditions, and maintenance

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Special Terms and Issues

I. Reconcile PPA Terms • The Developer’s attorney should reference the

PPA as to (1) scheduled date of initial commercial operations, (2) penalties for delay in meeting start date for commercial operations, (3) caps on liability, (4) any periodic reporting requirements, (5) insurance and (6) any special force majeure clauses

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Special Terms and Issues

II. Reconcile Real Estate Lease Terms • Special bonds potentially required in dealing

with construction liens • Projects proposed on public lands overseen by

the federal government must complete a full Environmental Impact Statement. The review process can take years

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Special Terms and Issues III. Bringing the Facility Online • Solar clients often get excited by the prospect of bringing part of

the facility online early as the rest is constructed. • Check the PPA to see if you can start generating prior to completion

of the entire project or in lower MW output • Consider similar limitations and registration requirements if you are

a merchant farm • WARNING! Make sure that you have checked to see that the

interconnect agreement is signed before attempting to transmit! • WARNING! Finally, if you bring part of the facility online before the

rest, this may impact the start date of your warranties!

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Special Terms and Issues IV. Testing • The project should not change hands until AFTER completion of performance testing. The

Contractor should remain liable for DLDs until the resource entity operates as contracted OR the Contractor ponies up the PLDs (if the facility will not meet contract requirements)

• PRACTICE TIP! Reserve the right in the EPC contract for the Developer to demand payment of the PLDs and accept the power station

• PRACTICE TIP! Be sure to give the Contractor the meaningful chance to fix the resource entity (if non-compliant) if it fails to meet the performance guarantees on the first try. PLDs can be quite large. Not giving this leeway almost certainly will cause the overall contract price to be much higher than necessary as the Contractor will have to budget the risk.

• PRACTICE TIP! Try to put as much of the technical parameters of the testing as possible in the contract, including methodology, testing conditions (e.g. atmospheric conditions), and the margin of error allowed

• The Developer’s attorney needs to ensure that testing (both output and reliability) is required by the contract both (1) of individual panels and (2) of the entire resource entity at the same time

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Special Terms and Issues V. Binning (aka Current Mismatch) & Flash Testing • YOU’RE ONLY AS GOOD AS YOUR WEAKEST LINK. When several modules

are installed on one string (series connection), modules with the lowest current at maximum power will hinder production of the entire string. This is called current mismatch.

• Manufacturers typically bin the modules in 5 W to 10 W bins, so there can be a 5% difference or greater between the power output of modules with identical model numbers!

• PRACTICE TIP! To limit current mismatch, the Contractor must verify that all of the modules connected on one string are showing similar max power current. Be sure to place necessary limitations in the “Procurement” section of the scope of work.

• This may be abundantly obvious, but also make sure your Contractor only purchases panels that have flash reports to confirm that the panels work as described

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Section III: EPC Guaranties/Warranties

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EPC Guaranties/Warranties

Manufacturers' Warranties

Integrator's Warranty

Integrator's Performance Guaranty

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EPC Guaranties/Warranties Manufacturer’s Warranties

PV Modules

Inverters

Mounting Systems

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EPC Guaranties/Warranties Manufacturer’s Warranties – PV Module Warranties

Duration and Scope

10 years for defects in materials and workmanship

12.5 years 90% output

25 years 80% output

Assignment - Generally runs to the original owner and all subsequent owners of PV System

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Common Warranty Exclusions/Limitations

Damage and/or failure caused by modules installed in a location that exceeds operating conditions

Damage and/or failure caused by non-compliance with national and local electric codes

Damage and/or failure caused by installations not in conformance with the modules’ specifications, installation manuals, operation manuals, or labels attached to the modules

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Damage and/or failure caused by improper wiring, installation or handling

Damage and/or failure caused by devices and/or parts other than the modules or by mounting methods of such devices and/or parts

Damage and/or failure caused by improper or incorrectly performed maintenance, operation or modification

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Damage and/or failure caused by removal from the original place of installment

Damage and/or failure caused by repairs not in accordance with manufacturer's instructions

Damage and/or failure caused by inappropriate handling during storage, packaging or transportation

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Damage and/or failure caused by external shock such as flying objects or external stress

Damage and/or failure caused by environmental pollution such as soot, or acid rain

Damage and/or failure caused (as determined in manufacturer's sole reasonable discretion) by direct contact and/or exposure to salt water

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Damage and/or failure caused by natural forces (earthquakes, tornados, floods, lighting, hurricanes, heavy snow, etc.) and fire, power failures, power surges or other unforeseen circumstances that are beyond manufacturer's control

Damage and/or failure caused by terrorist acts, riots, war or other man-made disasters

Damage and/or failure caused by external stains or scratches that do not affect output

Damage and/or failure caused by sound, vibration, rust scratching, or discolorations that are the result of normal wear and tear, aging or continuous use

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EPC Guaranties/Warranties Manufacturer’s Warranties – Inverter Warranties

Duration - 10 to 20 years from date of purchase or operation

Assignment - Generally runs to the original owner and all subsequent owners of PV System

Scope - defects in materials and workmanship

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Common Warranty Requirements

Provide notice of claim within a set period of time

Provide access within a set period of time

Product cannot be damaged in shipment

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Product cannot be improperly installed, operated or maintained

Product must be installed, operated or maintained in accordance with manufacturer manuals

Manufacturer monitoring systems and inspections

Product must only be installed in an environment for which the product was designed

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Damage, malfunction or degradation caused by repair or replacement using part or service provider not provided or authorized by manufacturer

Damage, malfunction or degradation caused by third parties, acts of God, vandalism, etc.

Damage, malfunction or degradation caused by other third party components of PV System

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Damage, malfunction or degradation caused by non-authorized modification of the product

Damage, malfunction or degradation caused by improper maintenance

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Mounting System Warranties

Duration - 10 to 20 years from date of purchase or operation

Assignment - Generally run to the original owner and all subsequent owners of PV System

Scope - defects in materials and workmanship

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Must be installed in accordance with all applicable laws and building codes

Must be installed in accordance with manufacturer's instructions

Must be installed by manufacturer authorized installer

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Must not be modified except in accordance with written authorization from manufacturer

Must only be installed in an environment for which the product was designed

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Damage caused in shipping

Damage caused by improper handling

Damage caused by repair or attempted repair by other than an authorized service provider

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Cosmetic Damage

Damage caused by accident, misuse or acts of God

Liability not to exceed purchase price of original product

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EPC Guaranties/Warranties Integrator’s Warranty

Duration - industry standard is five years from Commercial Operation Date (COD)

Some Integrators give warranties for as long as ten years from the COD

Assignment - runs to the original owner and all subsequent owners of PV System

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Scope – Design, engineering, materials, labor and workmanship

Integrator's warranty for equipment with manufacturers' warranties often either excludes the equipment with manufacturers' warranties or is secondary to the manufacturers' warranties for that equipment

Some integrator's warranties are conditioned on the integrator performing the O & M for the System

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Limitation of liability to contract price

No special, consequential or punitive damages

Exclusions for damage or malfunction caused by improper/unauthorized operation, maintenance or repair

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EPC Guaranties/Warranties EPC Agreement Provisions Governing

Manufacturers’ Warranties

List of manufacturers' warranties provided and duration of same

Attach forms of manufacturers' warranties as exhibits to agreement

If make and model of equipment not yet determined, attach various alternative equipment manufacturers' warranties as exhibits to agreement

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EPC Guaranties/Warranties EPC Agreement Provisions Governing

Manufacturers’ Warranties

Undertaking that all manufacturers' warranties will run to owner

Undertaking that integrator will design and install PV System in accordance with all manufacturers' requirements

Undertaking that all manufacturers' warranties will be in full force and effect as of final completion date

Condition to release of retainage

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EPC Guaranties/Warranties Integrator’s Performance Guaranty

Duration – five (5) to ten (10) years from COD

Payments – Annual negative difference, if any, in kWh, between "guaranty level" and actual energy production multiplied by the rate the Owner receives for electricity generated by the PV System

Industry standard – can't get lost SREC revenue

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Conditioned on EPC Contractor performing O &M

Except in case of EPC contractor default under O & M Agreement

Conditioned on proper use and operation of PV System by Owner

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Guaranty Level – eighty-five to ninety-five percent (85% - 95%) of the estimated first year PV System production with annual one percent (1%) degradation

Guaranty level adjusted for actual weather and solar radiation conditions

Guaranty level adjusted for times PV System not operating due to Force Majeure or Owner or third party actions

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Section IV: Lenders’ Issues

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Lenders’ Issues Preconditions to Payment

Completion of work for progress/final payments certified by PV System design professional

Lien waivers provided prior to progress/final payments

Integrator

Subcontractors

Materialmen

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Lenders’ Issues Owner/Borrower Default of EPC Agreement

Notice of Owner/Borrower default to Lender

Lender right but not obligation to cure Owner/Borrower default

Extended cure period for Lender

Free Assignment to Lender and Lender's assignee

UTILITY SCALE SOLAR PV: MISCELLANEOUS BANKRUPTCY ISSUES

The Automatic Stay

• When a Debtor files for bankruptcy relief, essentially all collection activities are “stayed”; claims must instead be processed through the bankruptcy proceedings. 11 U.S.C. 362(a).

• Failure to honor the automatic stay can get you into hot water, especially if you knew that the Debtor had filed bankruptcy. 11 U.S.C. 362(k).

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Executory Contracts • Many of the contracts in place in an EPC agreement may, at least at first

glance, appear to be “executory contracts” • Subject to the court’s approval, the bankruptcy trustee may assume or

reject executory contracts. 11 U.S.C. 365(a). • The Bankruptcy Code fails to define “executory contract”:

– An executory contract is one “on which performance is due to some extent on both sides.” N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 522 (1984).

– An executory contract is one “under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” Sharon Steel Corp. v. National Fuel Gas Distrib. Corp., 872 F.2d 36, 39 (3d Cir. 1989) (citing cases).

• Common Examples: real estate leases, equipment leases, insurance policies, unexpired collective bargaining agreements, development contracts, IP license agreements

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Executory Contracts (cont.)

• Three things to remember with executory contracts:

• The Debtor gets to decide whether to accept or reject

• In the meantime, the Creditor must keep performing (with limited exceptions)

• If the Debtor assumes the contract, it must cure all defaults and provide adequate assurance that it can perform in the future

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Issues in Bankruptcy Scenario 1: The Developer falls behind on payments to the Contractor but tells Contractor to keep working. Developer then files for bankruptcy relief. Your client is the Contractor. • Absent additional facts, the EPC probably is an executory contract.

Depending on your Circuit’s case law, the contract might have been so fully performed as to no longer be executory

• If executory, learn the Developer’s intentions a.s.a.p. (must reject or accept prior to confirmation of the plan)

• If executory, until learning of rejection, Contractor, as a default, will need to keep working—check the exceptions in § 365!

• Be wary: pre-petition payments from the Developer could be treated as preferences!

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Issues in Bankruptcy Scenario 2: The equipment supplier filed for bankruptcy relief. The Contractor now claims that the automatic stay under 11 U.S.C. 362 constitutes a force majeure event and stops work. The contract is silent. Your client is the Developer. • Feel bad for yourself. You failed to consider bankruptcy in

the force majeure clause, which is more than reasonably foreseeable

• Claim against Contractor (unknown outcome) • Contract with equipment supplier is not likely to be

executory. If payment was tendered already, Contractor should look to assert a security interest

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