The Importance of Solar Project Site Control Issues
By Fred Greguras (Palo Alto) and Stan Lewandowski (Palo Alto)
The power purchase agreement (“PPA”) is the primary source of revenue in a solar project financing for debt service to a lender as well as for returns to other investors and the project developer. If the solar facility must be removed from the rooftop or ground site because of foreclosure or other superior rights, then the project cannot generate any more electricity which means there will not be any more revenue from the PPA, from electricity production subsidies such as production-based incentives or from the sale of renewable energy credits or certificates. The predictability of the revenue (or lack thereof) is the key factor in the financeability of the project. There cannot be any revenues if the solar facility is no longer operating. The value of the installed solar equipment by itself is not adequate to protect lenders or investors. While the security interests in a loan financing will include a UCC-1 filed on the solar equipment, the equipment has little resale or salvage value once it is installed and will have little value for a lender or other investor.
Site control means control over the rooftop or ground site where a solar facility will be located for the term of the PPAso that the PPA revenues can be generated without any interruption. A key business objective in financing due diligence is to identify and implement site control protections which increase the probability that the solar facility will generate such revenues for the life of the PPA. A lender will want site control for the term of its loan. The borrower/project owner will want the revenues to continue for the life of the PPA to provide a return for itself and other investors. The investors and project owner have a common interest which should drive cooperation on these issues.
The title report for the property where the project will be located will identify the deeds of trust, easements for utilities, rights-of-way, mineral and other rights and encumbrances which may restrict or prevent the use of the land for the development of the solar project. For example, a project owner may be leasing the rooftop of a building which is subject to a financing party’s deed of trust. The most common encumbrances on a title report that must be addressed are deeds of trust or mortgages held by parties that financed the property. The risk to the solar project owner is removal of the solar facility if the land owner defaults and foreclosure occurs. The title report should be ordered and reviewed at the outset of the project to identify what site protections may be needed to mitigate the financing risks and to quickly determine if they can be obtained.
Site Control Agreements
The project owner must have a basic site control agreement in place in order for a lender or other investor to consider financing the project. This agreement is usually a lease, easement or license. This agreement provides the project owner with the initial right to use the property for the solar project, subject to any third party rights to the property. The time period for this agreement must be for at least the same term as the PPA, including extensions. The project owner must have the right to operate the solar facility on the site for the life of the PPA for predictability of revenue. We have seen due diligence situations where the basic site control agreement is for a shorter term than the PPA.
In general, the lease is the strongest type of agreement for basic site control. While the label of the agreement is important, the actual provisions in the agreement, not the label, will control. The basic site control agreement must describe the parties’ rights and obligations in detail, including access to the site, non-disturbance and termination provisions and not depend on a label. The provisions in an agreement labeled “lease” may be weak and put revenue streams at risk. For example, in due diligence, we have seen leases without any non-disturbance covenants from the lessor and termination provisions without any notice and cure period so defaults can be remedied.
Following review of the title report and basic site control agreement, additional agreements from third parties and/or amendments to the existing agreement may be needed to increase the predictability of the revenues for the life of the PPA. A site non-disturbance agreement (“SNDA”) is often used with third parties for this purpose. A subordination of mineral rights, release or surface waiver agreement may be needed to protect solar surface rights against mineral rights.
Not all SNDAs are the same. They have to be carefully prepared for each project and are often negotiated. In an SNDA for a deed of trust holder, for example, the holder agrees that the solar facility may not be removed from the premises without the investor’s consent, that the roof or ground lease will continue in effect following a foreclosure, the facility is not a fixture, waives any right to the facility, provides rights of access to the premises, etc. The purpose of an SNDA is to keep the facility on the roof following a foreclosure so it can continue to generate revenue if the next occupant agrees to a PPA. There is no assurance of continuing revenue but there is the possibility, particularly if the kWh rate is lower than the utility rate.
If the site is owned by the project owner (or leasehold is not encumbered by the land owner) an investor will still want an SNDA which restricts any future encumbrances on the solar project site.
There is no obligation for a third party rights holder to sign an SNDA so the project owner may have little if any leverage. We believe it is important to ask a third party only once to sign an SNDA; therefore the first SNDA must mitigate all of the risks. A cooperative third party rights holder may become uncooperative if multiple requests are dribbled out rather than only one request. The third party’s willingness to sign an SNDA needs to be tested early as the site control risk can be a deal killer.
Some third party rights holders may only be willing to sign an acknowledgement that the solar facility is personal property and not a fixture attached to the land estate. In this case, the solar facility may have to be removed upon a foreclosure. The investor holding the security interest would have first rights to the equipment based on its UCC-1 filing, but there would not be any possibility of continuing revenue because the facility is no longer on the roof. The UCC-1 would be terminated as the equipment is removed from the roof. When such an acknowledgement is all that can be obtained, a lender may require more credit support (such as a guaranty) or may not be prepared to offer the financing. The feasibility of obtaining an SNDA should therefore be determined as early as possible since it may substantially postpone or even derail the deal if it is not possible to secure an SNDA.
Mineral Rights
Mineral rights may be identified in a title report for a proposed project. Mineral rights may be granted by lease or license, or may be created by the division of the surface and subsurface of the property into two separate estates.
In general, where the surface estate and subsurface estate (i.e., mineral rights) have been separated, the law provides the mineral rights owner with the right to the "reasonable use" of the surface in order to remove the minerals but the mineral rights owner must also reasonably accommodate the use of the surface by the surface estate owner as well. Many mineral rights conveyance and lease documents will have been drafted by the purchaser or lessee so the express language must be reviewed carefully in order to determine if there is any conflict with the surface rights needed to build and operate the solar facility. In many instances, the conveyance language may convey a right of access across the whole of the surface estate for the purpose of providing the owner of the mineral rights with access to the minerals which effectively permits the owner to remove minerals at any time, by any means, and from any location, regardless of the consequences to the surface owner. In such a situation, a surface rights waiver agreement restricting the access rights of the mineral rights owner to certain designated areas will be needed to protect the solar facility site. Even if the conveyance document is silent with respect to the surface rights, the general rule is that to the extent that the mineral rights owner has the right to access subsurface minerals, the rights of the mineral rights owner are superior to those of the surface owner so a surface rights waiver agreement will likely be needed for investor predictability.
Financing Consents
An investor may also want an agreement with the lessor or other holder of rights to the project site or structure which provides the investor with additional protective rights such as the opportunity to cure any default by the project owner/borrower under the site control agreement before termination rights may be exercised, review and approval rights with respect to any required financing assignment, so-called “step-in” rights that allow the investor to take control of the project and carry out the activities required for the continued operation of the project so it can continue to generate revenue in the event of a project owner/borrower default, as well as expanded investors rights in the event of a foreclosure.
Notice to Third Parties: Recording
The purpose of recording is to put third parties on notice of the solar project owners’ rights in the property and to perfect a security interest in the solar equipment and other collateral. Both the primary land rights agreement and any third party rights agreements such as an SNDA or surface rights waiver agreement should be recorded with the applicable county recorder’s office as notice of the rights against any third party. In the U.S., a UCC-1 financing statement should also be filed to perfect a security interest in the solar equipment and other collateral in the appropriate state or local office.
Conclusion
In summary, due diligence should be done early on site control-related issues. Investors should start with the review of the basic site control agreement and title report for the relevant property to promptly identify unacceptable risks that need to be immediately addressed. Mitigating the risk may involve execution of SNDAs, agreements with mineral rights owners and others. The sooner the site control-related issues are addressed, the better for all interested parties.
