Critical Issues in Joint Development and Joint Ownership Projects:Roles, Rights and Obligations

Critical Issues in Joint Development and Joint Ownership Projects:Roles, Rights and Obligations

William S. Andrews

Nixon Peabody LLPSuite 900401 9th Street, N.W.Washington, DC  20004-2128

wandrews@nixonpeabody.com

202-585-8392

Critical Issues in Joint Development and Joint Ownership Projects:

Roles, Rights and Obligations

Critical Issues in Joint Development and Joint Ownership Projects:

Roles, Rights and Obligations

• The Players – Who Sponsors Projects?

• Project Phases

• Development Phase – Project Development Agreement

• Financings: Fundamental Principles and Coordination

• Acquisition of an Ownership Interest

• Construction & Operations Phases – Participation Agreement

• Withdrawal and Payment

The Players — Who Sponsors Projects? The Players — Who Sponsors Projects?

• Utilities– Base load needs

– Plant is integral to its system over the long term

– Exert considerable control

– Looking for participants to take advantage of economies of scale

The Players — Who Sponsors Projects? cont’dThe Players — Who Sponsors Projects? cont’d

• Independent Developers – Looking for investors or joint tenants

– Serving customers under PPAs / selling into the market on a merchant basis

– Looking to build or expand its generation or related core business (long-term outlook)

– Looking to profit from the sale of its interest (short-term outlook); will seek broad rights to sell its interest

– Will want to exert control to protect its investment

The Players — Who Sponsors Projects? cont’dThe Players — Who Sponsors Projects? cont’d

• Public Power Entities / Electric Cooperatives– Base load needs

– Long term objectives

– Generally will be looking to participate with other joint tenants to take advantage of economies of scale

– Generally will look to exert proportional control, but with elements of blocking control for significant decisions

Ownership ScenariosOwnership Scenarios

50%

50%

33%

33%

33%

65%

5%10%

20%

20%

25%

26%

14%

10%5%

Development

FinancialClosing Retirement

Construction Operations

Project PhasesProject Phases

When does relationship commence?

• Cost and sharing/risk sharing• Acquisition of ownership interest• Withdrawal Rights

Development PhaseDevelopment Phase

Development

Development Models Single Sponsor Driven Development Models Single Sponsor Driven

65%

5%10%

20%

Retirement

Development Construction Operations

Financial Closing

Cost and Risk Sharing

Acquisition of Ownership Interest

Development Models Single Sponsor DrivenDevelopment Models Single Sponsor Driven

• Last Look — “No skin in the game”• No Project Development Agreement to formalize roles, rights

and responsibilities• Communication is often less routine• Development period activities

– Due diligence– Negotiating Asset Purchase Agreement (APA) and

Participation Agreement (PA)

Development Construction Operations

Financial Closing

Cost and Risk Sharing

Acquisition of Ownership Interest

Retirement

Development Models Single Sponsor Driven cont’d

Development Models Single Sponsor Driven cont’d

• APA signed just prior acquisition of the interest (PA, an exhibit)

• Interest will be acquired at the Financial Closing• PA signed at Financial Closing upon acquisition of

the interest • Coordinating Financial Closing is more challenging

Development Construction Operations

Financial Closing

Cost and Risk Sharing

Acquisition of Ownership Interest

Retirement

Development Models Multiple Owner Driven Development Models Multiple Owner Driven

20%

25%

26%

14%

10%5%

Development Construction Operations

Financial Closing Retirement

Cost and Risk Sharing• Execution of Project Development Agreement

and Asset Purchase Agreement

Acquisition of Ownership Interest• Execution of Participation Agreement• Financial Closing

Withdrawal Rights• Full

• Limited

• None/Assignment

Development Models – Multiple Owner DrivenDevelopment Models – Multiple Owner Driven

• Participants share development costs and risks proportionately

• Greater need for investment protection during development phase

• Greater voice in development decisions for minority decisions

Retirement

Development Construction Operations

Financial Closing

Cost and Risk Sharing• Execution of Project Development Agreement

and Asset Purchase Agreement

Acquisition of Ownership Interest• Execution of Participation Agreement• Financial Closing

Withdrawal Rights

Development Models – Multiple Owner Drivencont’d

Development Models – Multiple Owner Drivencont’d

• Need for Project Development Agreement to specify Participants’ roles, rights and obligations

• Project Development Agreement and Asset Purchase Agreement executed during Development Phase

• Participation Agreement executed either at: – Financial Closing

– Instead of Project Development Agreement

Retirement

Development Construction Operations

Financial Closing

Cost and Risk Sharing• Execution of Project Development Agreement

and Asset Purchase Agreement

Acquisition of Ownership Interest• Execution of Participation Agreement• Financial Closing

Withdrawal Rights

Development Models – Multiple Owner Drivencont’d

Development Models – Multiple Owner Drivencont’d

• Ownership Interest will be acquired either at: – Financial Closing

– Upon earlier execution of the Participation Agreement

Retirement

Development Construction Operations

Financial Closing

Cost and Risk Sharing• Execution of Project Development Agreement

and Asset Purchase Agreement

Acquisition of Ownership Interest• Execution of Participation Agreement• Financial Closing

Withdrawal Rights

Development IssuesDevelopment Issues

• Establish the Facts– Access to project information (permits, real estate,

local taxes, fuel availability, cost and transportation)

– Development budget

– Initial construction budget

– Pro forma operating budget

Establish Roles, Rights and ObligationsEstablish Roles, Rights and Obligations

• Sponsor– Duty to pursue development

Permitting Additional Owners EPC Contract/Multiple Prime O&M Contract Real Estate Fuel Contracts/Plan Interconnection Agreement

– Agency (fiduciary standard)

– Duty to regularly inform other Participants

Establish Roles, Rights and Obligations cont’dEstablish Roles, Rights and Obligations cont’d

• Participants– Transmission

– Pay percentage costs

– Maintain confidentiality (applicability of open records statutes)

– Support development e.g. Permitting, political (state and local)

– Audit Rights

– Private Use Restriction – Preservation of Tax-Exemption

– Fees (Development, Administrative, Success)

Control of Development Control of Development

• Formation of Development Committee– Facilitates exchange of information; feedback

– Monthly meetings

– Financing Coordination

• Day-to-Day decision-making– Joint

– Entrusted to principal Sponsor

Control of Development cont’d Control of Development cont’d

• Minority Rights– Certain decisions require Supermajority/Double Majority

EPC Contract O&M Agreement Decisions that have Material Adverse Impacts Purchases of Real Property Other significant Binding Commitments

(e.g. Fuel, Transportation)

Withdrawal Withdrawal

• Sponsor Withdrawal– No guarantee of success – all parties lose investment

– Disposal of Assets: Distribution of proceeds

– Transfer of rights to other Participants

Withdrawal cont’dWithdrawal cont’d

• Participant Withdrawal– At any time prior to financial closing – lose investment

Unsatisfied with results of development Unable to arrange affordable transmission Better options

– Problem created for remaining parties (financing exception)

– Limiting Right of Withdrawal after agreed point Liquidated Damages Not permitted / Assignment Only Option

Financing: Fundamental Principles – Coordination

Financing: Fundamental Principles – Coordination

• Essence of joint ownership is sharing financial risk– Construction

– Long term operations

• The more diverse the ownership mix, the more credit information and coordination will be necessary.

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

• IPPs– Merchant

– Selling under PPAs

• Project Finance– Rated

– Subinvestment grade

– Leasing Structure

• Tax Exempts– Municipals

– Joint Action Agencies

• Issuing Tax-Exempt Bonds for 100% of Project Costs

• IOUs– Rate-based

– Through non-regulated entities

• Corporate Debt & Equity

• Commercial Bank Loan

• Project Finance

• Electric Cooperatives • Co-Bank/RUS

• CFC/RUS

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

• Generally, each Owner is responsible for its Owner financing and does not need the consent of the other Owners

• Goal: To close on a single mutually agreed date.– Always uncertainty until the last Owner is assured access

to capital

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

• Coordination Approaches– None

– Flexible

– Extensive

• Coordination Techniques– Coordinate updating of project information so Owners

seeking ratings present a common picture

– Early communication of financing plans and education of steps necessary to effect each plan

– Consider PILOT arrangements, Enterprise Zone and other tax issues early

– Launch financing efforts when agreed project elements have clear definition

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

Permits Construction costs Real estate Ownership percentages

– Credit standing of Owners

– Financing plans

Fuel and Fuel Transportation Strategy

Operating strategy Participation Agreement finalized Asset Purchase Agreement

finalized Weekly coordination meetings

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

– Develop strategy for dealing with lender comments on transaction documents

– Anticipate consent requirements

– Determine common approach to collateral Avoid intercreditor agreements if possible

Financing: Fundamental Principles – Coordination cont’d

Financing: Fundamental Principles – Coordination cont’d

• Encourage bank / private equity financings to be arranged first. Capital Markets transactions require disclosure and cannot easily accommodate changes

• Transactions where Owners well understand the financing of requirements of their Co-Owners tend to have the least disruptions prior to closing

1. Governance & Decision-making1. Governance & Decision-making

• Decision-making vested in Management Committee with representation proportional to ownership

• Day-to-day decisions

• Extraordinary Decisions– Project Budgets: Construction & Operations– Project Agreements, e.g. O&M, Fuel– Affiliate Contracts– Restoration, Condemnation, and Retirement– Permit Changes– Decisions with Disproportionate Effect– Capital Improvements

Control ThresholdsControl Thresholds

• Majority• Supermajority (66.7%, 75%, 80%)• Double Majority (# & %)• Unanimous

33% 33%33%

50%50%80%

5%5%

10%

20%25%

26%14%

10%5%

2. Operating Structure for Asset Management / Operations

2. Operating Structure for Asset Management / Operations

• Owner-Operator managed and operated• All Owners manage and operate• Formation of Project Company• Asset Management Contract / O&M Contract

3. Fundamental Dispatch Principles3. Fundamental Dispatch Principles

• Each Participant entitled to its Percentage of Energy, Capacity and Ancillary Services

• No Participant may deliberately take a greater share• Minimum Scheduling Requirements

– Setting the level

– Remedy for failure to schedule

3. Fundamental Dispatch Principles cont’d3. Fundamental Dispatch Principles cont’d

• Scheduling– Imbalance Charges: Inadvertent use of more or less energy

on an integrated hourly basis assessed pro rata to the scheduling owners

– Scheduling Outages

• Fuel Allocation/Reconciliation– Heat rate adjustments for less than full load

Impact on load-following

• Authority to Change Dispatch Principles

4. Joint and Several Liability/Several Liability4. Joint and Several Liability/Several Liability

• Several Liability• Flow down to Project Agreements

5. Assignment – Transfer of Interests5. Assignment – Transfer of Interests

• Which are permitted and which require consent?– All assets to be transferred

– Effect on Project Agreements (e.g. O&M)

– Retention of expertise Who is your partner? Transfer by a principal sponsor

– Tension between free transferability and loss of expertise

– Maintenance of numerous percentage for minimum period

6. Expansion6. Expansion

• Rights jointly owned• Rights retained by Sponsor• Sponsor grants right of first refusal/option

– Common facilities: Definition & Valuation

– Priority/Adverse Impact

7. The Collateral Package7. The Collateral Package

• Joint Owners are tenants-in-common, each owning anindividual undivided interest in Project Assets

• Project-based Collateral is limited to a joint tenant’s undivided ownership interest

• No encumbrance of another joint tenant’s undivided interest or any Project asset

• No right to partition of Project Assets

• Lender can cure, but must assume position of its borrower

8. Impact of a Co-Tenant Financing8. Impact of a Co-Tenant Financing

• Tax-exempt financing– Use of tax-exempt financing means no private

business use– Contracts with operators must be Qualified Management Agreements:

the duration of the contract and incentive fees for performance may be restricted

– Under certain circumstances applicable to cooperatives, there may be restriction on sales of energy, capacity or ancillary services to avoid certain income restrictions

• Project Finance financing– EPC contracting approach

9. Payment Default Dilemma

The essence of joint ownership isshared financial risk

9. Payment Default Dilemma

The essence of joint ownership isshared financial risk

• Make obligations recourse to creditworthy entities.• Require pro rata sharing of development costs to

make sure all entities are fully and increasingly invested.

• Prevent withdrawal to be certain that entities do not have right to rescind commitment

9. Payment Default Dilemma cont’d 9. Payment Default Dilemma cont’d

• Impose minimum credit requirements• Require at closing (remedy)

• Require during operations (remedy)

• Increase security upon downgrade or fall below a minimum credit rating (consider sliding scale)

• Invoicing and payment in advance• Disputed Payments to be made as a condition of

maintaining a dispute

9. Payment Default Dilemma cont’d 9. Payment Default Dilemma cont’d

• Require working capital and maintenance reserves (all phases)• Tie pre-funding to payment default cure periods

• Reasonable period to vacate automatic stay

• Default Remedies – Make non-payment painful• Dilution (proportional vs. acclimated (eg., % of FMV))

• Extinguish interest at preferential price

9. Payment Default Dilemma cont’d 9. Payment Default Dilemma cont’d

• Interim Remedy• Loss of right to energy, capacity and ancillary services

• Step-up or limited step-up (voluntary or involuntary)• Restrict Project Lender collateral to Ownership

Interest, thereby forcing Lender to fund or risk dilution or loss of collateral

9. Payment Default Dilemma cont’d9. Payment Default Dilemma cont’d

• Pre-funding of construction costs until COD• Tie pre-funding* to default cure periods

• Consider tying pre-funding to reasonable period to vacate automatic stay

• Build reserves for scheduled maintenance with goal of fully pre-funding scheduled maintenance

• Build reserves for capital improvements, other events

*Pre-funding could be cash or other security

William S. AndrewsNixon Peabody LLP

Suite 900401 9th Street, N.W.

Washington, DC  20004-2128wandrews@nixonpeabody.com

202-585-8392