Below are summaries of the noteworthy decisions, laws and requirements impacting the commercial lending industry which occurred or took effect in 2018. Please feel free to contact us for additional information or details on any of the items listed below and/or to discuss whether updates to your loan documents may be needed to address the same.

1. New, Improved Rules for High Volatility Real Estate Loans

On May 24, 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act, which reformed the widely unpopular rules relating to high volatility commercial real estate, or HVCRE, loans. Under the new rules, only capital equal to 15 percent of the real property’s appraised, as completed value, tested at closing, is required to remain in the project, and this is only until the loan has been reclassified as a non-HVCRE ADC loan. A loan can be reclassified by a lender as a non-HVCRE ADC loan once the project has been substantially completed and has stabilized such that the cash flow generated by the project satisfies the minimum debt service requirements, in each case, using the lender’s underwriting criteria for permanent financing. In addition, in order to satisfy the borrower’s minimum capital contribution requirement, lenders can count the appraised value of the real property toward the borrower’s satisfaction of the borrower’s minimum capital contribution requirement. Moreover, any loan made prior to January 1, 2015, is excluded from the definition of an HVCRE ADC loan and lenders do not have to assign a heightened risk weight to the same. Similarly, loans for the acquisition, or refinancing of existing income-producing real property “where the cash flow being generated by the real property is sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings” are expressly excepted from the definition of an HVCRE ADC loan. The prior alert, including a detailed analysis, can be found here.

2. Delaware Limited Liability Company Act Division Statutes

Effective August 1, 2018, the Delaware Limited Liability Company Act was amended, among other things, to permit any Delaware limited liability company (LLC), to divide into two or more LLCs with the dividing LLC either surviving or ceasing to exist, pursuant to a plan of division. Upon the division becoming effective in accordance with the requirements set forth in the statute, all assets, debts, liabilities and duties, without any further action, are allocated to and vested in the division companies as specified in the plan of division, and shall not be deemed, as a result of the division, to have been assigned or transferred to such division company. In addition, unless specified in the plan of division, the dividing company is not required to wind up or will not be deemed dissolved by reason of the division. The question becomes whether representations, warranties and covenants restricting fundamental changes in existing loan documents adequately protect lenders from assets leaking outside the loan party structure when under a division, assets are not “transferred” or “assigned” and there is no consolidation, winding up or dissolution of the original entity. The statute provides some protection with respect to any LLC formed prior to August 1, 2018, that is party to any agreement entered into prior to August 1, 2018, which by its terms restricts, conditions or prohibits a merger, consolidation or transfer of assets of such LLC. In this regard, such restriction, condition or prohibition shall be deemed to apply to a division. In addition, the new law allows for an LLC’s operating agreement to provide that the LLC does not have the power to divide under such statue. As such, in addition to ensuring that appropriate restrictive language is included loan documentation entered into or amended after August 1, 2018, lenders and their counsel should require prohibitive language in an LLC’s operating agreement.

3. Compliance Required with Updated Customer Due Diligence Requirements

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued the Customer Due Diligence Requirements for Financial Institutions (CDD Rule) under the Bank Secrecy Act, which became effective July 11, 2016 with required compliance by May 11, 2018. FinCEN proffers that the CDD Rule is intended to clarify and strengthen customer due diligence requirements for certain financial institutions, including, among others, banks. The CDD rule includes four core elements: (i) “customer” identification and verification, (ii) beneficial ownership identification and verification ( i.e., any individual who owns 25% or more of, or controls, a legal entity customer at the time a new “account” is opened), (iii) understanding the nature and purpose of customer relationships to develop customer risk profiles, and (iv) ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. The conditions precedent, representations and warranties and covenants sections of any loan agreement should be revised to reflect the CDD Rule requirements (e.g., delivery of the appropriate certification, the accuracy of the information provided therein and the covenant regarding any change to such information).

4. Default Interest Rate Provision Held Unenforceable by California Bankruptcy Court 

In July of 2018 the U.S. Bankruptcy Court of the Central District of California in In re: Altadena Crossing LLC, 2018 (Case No: 2:17-bk-14276-BB), found that a default interest provision in a loan agreement of 5.0% above the existing nondefault interest rate, which was the market default rate at the time, constitutes an unenforceable penalty. The Court concluded that default interest provisions are akin to liquidated damages under a contract and therefore must have a reasonable relationship to the anticipated actual damages foreseeable at the time of contract formation between the parties. The Court looked to Section 1671(b) of the California Civil Code to guide its analysis of the reasonableness of the relationship between the default interest provisions and the actual damages anticipated by the lender at the time of the agreement. Here, the default interest provision was found to be unenforceable because it did not have a reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach at the time the contracts were made, but rather were intended to serve as a penalty to incentivize avoidance of events of default. Although the precedential significance of the Altadena decisions remains to be seen, in the meantime, lenders should attempt to incorporate prophylactic language in their loan agreement which, among other things, acknowledges the reasonable of the default interest rate provisions.

5. Challenges to Collateral Descriptions in UCC-1 Financing Statements

In 2018, two decisions challenged the sufficiency of collateral descriptions in UCC-1 financing statements. The District Court of Puerto Rico in Fin. Oversight & Mgmt Bd. v. Altair Global Credit Opportunities Fund (A), LLC, 2018 U.S. LEXIS 140206 (D.P.R. August 17, 2018) held that a UCC-1 financing statement is ineffective to perfect a security interest if the public document to which its collateral description referred is not available at the local clerk’s office where UCC records are maintained. Here, the UCC-1 financing statement included a collateral description describing the collateral as “The pledged property described in the Security Agreement attached as Exhibit A hereto and by this reference made part hereof.” The filed financing statement attached the security agreement but did not attach the Pension Funding Bond Resolution which was incorporated by reference into the security agreement for purposes of the description of the pledged property (which was not otherwise described in the security agreement itself). The referenced Resolution was posted on several websites but was not available for review at the local clerk’s office that maintains UCC records. As such, the Court held that any search, which must extend beyond the local clerk’s office, is ipso facto too burdensome for Article 9 purposes. The prior article published in Law360, which includes a detailed analysis can be found here.

Similarly, the U.S. Bankruptcy Court for the Central District of Illinois in In re I80 Equipment, LLC, No.17-81749, 2018 WL 4006294 (Bankr. C.D. Ill. Aug. 20, 2018) held that a financing statement which contained no description of collateral within the statement itself, but instead referenced the definition of “collateral” in an underlying security agreement without attaching the security agreement to the financing statement, was insufficient to “reasonably identify” the collateral subject to the security interest pursuant to the Article 9 requirements. Accordingly, the secured party failed to protect its security interest. These decisions suggest that financing statements may be insufficient to perfect if not all applicable defined terms are specifically included on the financing statement itself or on an exhibit annexed to the financing statement.

6. Second Lien Lenders Prevail in Intercreditor Dispute

Late in the year, in In re MPM Silicones, LLC, No. 15-CV-2280 (NSR), 2018 WL 6324842(S.D.N.Y. Nov. 30, 2018), of which the opinion was amended on January 4, 2019 at 2019 WL 121003, the U.S. District Court in the Southern District of New York found in favor of second lien noteholders (collectively, the “Seconds”) in affirming the U.S. Bankruptcy Court’s dismissal of the senior lien noteholders, which includes the senior lien noteholders (collectively, the “Seniors”), claims in bankruptcy related to the Seconds’ alleged breach of the governing intercreditor agreement (“ICA”) by, among other things, (i) voting in favor of the troubled debtor’s reorganization plan that Seniors opposed, (ii) Seconds’ receipt of equity pursuant to the reorganization plan in exchange for release of claims to certain shared collateral and (iii) Seconds’ receipt of and failure to turn over certain professional fees prior to repayment in full of the senior debt. The Seniors and the Seconds held liens in shared collateral (“Common Collateral”), the priority of which was set forth in the ICA. Seniors claimed that the Seconds’ actions violated the ICA agreement provision which prohibited Seconds from taking “any action that would hinder any exercise of remedies undertaken by the [Seniors] with respect to the Common Collateral” further that each Second “waives any and all rights it … may have as a junior lien creditor or otherwise to object to the manner in which the [Seniors] seek to enforce or collect the Senior Lender Claims or the Liens granted in any of the Senior Lender Collateral.” In addition, until Seniors are repaid in full, pursuant to the ICA, the Seconds expressly agreed to not take or receive any Common Collateral or proceeds thereof in its capacity as secured creditor. In finding in favor of the Seconds with respect to the interference claim, the Courts focused on the ICA provision which provided that “notwithstanding anything to the contrary” in the ICA, the Seconds, were entitled to exercise their rights and remedies as “unsecured creditors” against the debtor. Applying principles of statutory construction, the Courts found this provision trumped any other provision of the ICA. As such, “the Seconds, when acting as unsecured creditors, have unfettered reign to act against” the debtor. In addition, with respect to the turnover claims regarding receipt of common stock and certain fees by Seconds in connection with the restructuring, the Courts found as a matter of law that such common stock did not constitute “proceeds” of the Common Collateral and that the fees were received by Seconds in their capacities as unsecured creditors. Accordingly, the ICA was not breached.

7. California Commercial Financing Disclosures: SB 1235

The California Financial Code was amended by SB 1235, which was signed into law on September 30, 2018 and became the first law to impose standardized disclosure requirements on providers of certain commercial financing transactions (including factoring, asset based and cash flow loans, open ended credit-plans and lease financing transactions) similar to those associated with consumer financing transactions such as the federal Truth in Lending Act. The new law is limited in scope and intends to target the small business owner/borrower ostensibly to protect potentially less sophisticated borrowers by requiring standardized disclosures relating to the loan. In this regard, the disclosure requirements do not apply to banks, but do extend to any bank sponsorship arrangements through an online lending platform administered by nonbank lenders. Commercial financing transactions secured by real estate are also excluded from the new law as well as loans greater than $500,000. Required disclosures include: the total amount of funds provided; the total dollar cost of the financing; the term or estimated term; the method, frequency and amount of payments; a description of prepayment policies and until January 1, 2024, the total cost of the loan expressed as an annualized rate.

8. Affirmation of Seminal Material Adverse Effect Decision

In October of 2018, the Delaware Court of Chancery upheld, for arguably the first time under Delaware law, the buyer’s termination of a merger agreement because a material adverse effect (MAE) had occurred in Akorn, Inc. v. Fresenius Kabi AG , C.A. No. 2018-0300-JTL. On December 7, 2018, the Delaware Supreme Court affirmed the Court of Chancery’s decision in respect of its MAE findings. More specifically, the Supreme Court affirmed the Court of Chancery’s decision properly applied established Delaware MAE jurisprudence and further that the factual record supported the Chancery Court’s decision with respect to (i) the sudden and sustained deterioration in the seller’s business performance constituted an MAE under the merger agreement and (ii) the seller’s false regulatory-compliance representations were reasonably expected to result in an MAE, in each case, failing to satisfy conditions to buyer’s obligations to close. Accordingly, the buyer properly terminated the merger agreement.

9. Updated GAAP Lease Accounting Standards Are Now Effective

In 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which amended the generally accepted account principles (GAAP) reporting requirements of lessees in certain leasing transactions. In short, lessees must recognize the assets and liabilities for the rights and obligations created by leases with lease terms in excess of 12 months on their balance sheets, i.e., including operating leases which were previously off balance sheet activities. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for (i) public companies, (ii) not-for-profit entities that have issued securities that are listed on an exchange or an over-the-counter market, and (iii) employee benefit plans that file financial statements with the U.S. Securities and Exchange Commission. For all other entities, the new guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The FASB response to concerns that the additional lease liabilities will cause borrowers to foot fault debt service financial covenants in loan agreements is likely to be insignificant in part because the ASU characterizes operating lease liabilities as operating liabilities rather than debt.

The first offshore wind facility, the Block Island Wind Project off Rhode Island, achieved commercial operation in 2016. Since then, development efforts have stalled, with developers abandoning[i] early stage projects unable to overcome permitting challenges. But a recent spate of record-breaking sales of offshore wind leases appears to indicate renewed optimism for the future of the industry in the United States.

On December 14, 2018, three companies, Equinor, Mayflower Wind Energy (a joint venture between Royal Dutch Shell and EDP Renewables) and Vineyard Wind, bid a record-breaking $405 million for offshore wind leases near Massachusetts[ii]. The three leases span nearly 390,000 acres, which is at least 22 times the size of a typical U.S. offshore oil block, and the price is nine times the previous record sale of a 2016 New York offshore wind lease of $42.5 million.[iii] The Bureau of Ocean Energy Management estimates that when fully developed, the Massachusetts leases could support approximately 4,100 MW of commercial wind generation to power nearly 1.5 million homes.

On December 20, 2018, U.S. Wind sold its New Jersey offshore wind lease to EDF Renewables North America for $215 million.[iv] The lease will develop up to 2,500 MW of energy encompasses approximately 750 square kilometers.[v]

Going forward we may see even more large lease deals. On December 28, 2018, New Jersey Board of Public Utilities (NJBPU) received bids for its 1,100 MW offshore wind solicitation, the largest single state solicitation to date.[vi] In January 2018, Governor Murphy signed an Executive Order directing NJBPU to implement Offshore Wind Economic Development Act and move the state toward its 2030 goal of 3,500 MW of offshore wind generation.[vii] The 1,100 MW solicitation was NJBPU’s response to implement the Executive Order. In addition, Governor Murphy has asked NJBPU to consider two additional solicitations of 1,200 MW in 2020 and 2022.

The drivers behind the growing interest for offshore wind include dramatically lower cost, the perception of a more favorable political environment, and a strong state commitment to buy clean energy. In 2018, analysts describe growing investor confidence in the stability and predictability of the market, as President Trump continues to make territory available for new projects.[viii] Coastal states’ strong commitments to buy renewable electricity also strengthen wind developers’ confidence in the U.S. market and demand for offshore wind developments. A Bloomberg Intelligence analyst said that the Massachusetts bids “reflect the strength of state commitments to offshore wind”. According to Bloomberg New Energy Finance, U.S. offshore wind power is expected to reach 10,000 MW by 2030, compared to 30 MW today.

Troutman Sanders Capital Projects & Infrastructure Partner, John Leonti, will moderate a panel providing insight into the future of renewable energy projects during the Projects and Money 2019 Conference at The Roosevelt New Orleans on January 14 – 16, 2019.

Panel Description

The Future of Renewables

Wednesday, January 16, 2019 from 8:00 – 9:15am

Renewables have chalked up an impressive growth record. Yet, the availability of PPAs is dwindling, tax incentives are scheduled to decline (solar) and end (wind), prices are dropping and other challenges are surfacing. Are renewables a bubble set to burst or will we see hundreds of billions more invested in the future? This session will explore what it all means for the future of renewables.

Listen as our authoritative panel examines the key issues involved in renewable energy projects, offering insights on evolving industry norms and best practices.

Continue Reading Troutman Sanders Partner to Present on The Future of Renewable Energy

Troutman Sanders’ client, Alterra Power Corp. (Alterra), won the Renewable Energy M&A Deal of the Year award for its $1.1 billion acquisition by Innergex Renewable Energy Inc. (Innergex). Alterra is a diversified renewable power generation company based in Canada, and Innergex develops, acquires, owns and operates run-of-river hydroelectric facilities, wind farms, solar photovoltaic farms and geothermal power generation plants.

Troutman Sanders LLP served as U.S. counsel to Alterra, with a team led by partners Tom Rose and Shona Smith (Corporate) that included Cliff Sikora and Dan Larcamp (FERC), Mitch Portnoy (HSR), Megan Rahman (GICE), and Mark Goldsmith (Tax).

Troutman Sanders LLP has authored the 2019 Alternative Energy & Power Guide for Chambers and Partners. The firm’s Energy and Capital Projects & Infrastructure practices were asked by Chambers to be the exclusive contributor for the section. Associates Jamond Perry and Meghan Mandel and partners Christopher JonesAmie ColbyAnne DaileyBill DerasmoCliff Sikora, and John Leonti wrote and edited the guide.

View the Alternative Energy & Power Guide here.

Troutman Sanders’ energy practice groups have counseled utilities and other energy clients about changing regulatory challenges since the 1920s. The team handles matters across the energy-related sector including renewable energy, nuclear, and natural gas, energy construction, electricity, and energy storage.

On September 27, 2018, the U.S. Court of Appeals for the Second Circuit (“Second Circuit”) dismissed challenges to the New York zero emission credit (“ZEC”) program, ruling that: (1) the ZEC program is not field preempted by the Federal Power Act (“FPA”) because the ZEC program is not expressly tied to wholesale market participation or prices; (2) the ZEC program is not conflict preempted because it does not intrude on federal goals; and (3) the ZEC challengers did not have standing to raise a dormant Commerce Clause claim because they did not own out-of-state nuclear generators that they alleged were discriminated against by the ZEC program.

In August 2016, the New York Public Service Commission (“NYPSC”) issued the Clean Energy Standard Order (“CES Order”) adopting the ZEC program as part of a larger effort to reduce greenhouse‐gas emissions.  The program allocates ZECs to qualifying in-state nuclear energy generators that are financially “at-risk” of closing.  New York utilities are then required to purchase ZECs from either New York State Energy Research and Development Authority or the nuclear generators based on the price set by the NYPSC.  The initial price of each ZEC is calculated using the Social Cost of Carbon; however, the price of a ZEC decreases if a market price index, the calculation of which includes the clearing prices of certain regional wholesale energy auctions, exceeds a certain amount.  Accordingly, nuclear generators receive a fixed amount under the ZEC program for each MWh generated in addition to what the generators receive in the NYISO wholesale auctions.

In October 2016, ZEC challengers filed a complaint in the U.S. District Court for the Southern District of New York (“District Court”) alleging that the ZEC program was unlawful on two grounds.  First, the complainants alleged that the ZEC program is both field and conflict preempted by the FPA because it alters prices in the wholesale NYISO auction.  Second, the complainants argued that the program violates the dormant Commerce Clause by distorting interstate wholesale markets in favor of in-state nuclear generators.  In July 2017, the District Court dismissed the complaint (see July 31, 2017 edition of the WER).  On August 24, 2017, the case was appealed to the Second Circuit.

In its opinion, the Second Circuit first found that the ZEC program is not field preempted because it is not impermissibly “tethered” to wholesale market participation under U.S. Supreme Court precedent in Hughes v. Talen Energy Marketing, LLC (“Hughes”).  While ZEC challengers argued that Hughespreempts state programs if they are tethered to “FERC-regulated wholesale electricity prices,” the Second Circuit disagreed and stated that under Hughes, the “tether” is to “wholesale market participation.”  Because the CES Order does not expressly require ZEC recipients to participate in wholesale markets, the Second Circuit reasoned that there is no impermissible “tether” under Hughes.  Moreover, the Second Circuit held that any incidental effect of the ZEC program on wholesale prices is insufficient to state a claim for field preemption.  The Second Circuit also rejected the plaintiffs’ claims that the ZEC program conflicts with FERC’s goals of market competition, finding that FERC has previously approved state programs that incidentally affect wholesale market prices.  Finally, the Second Circuit found that ZEC challengers lacked standing to challenge the ZEC program under the dormant Commerce Clause because the plaintiffs’ asserted injuries arose from not owning nuclear generators, not from owning out-of-state nuclear generators that were being allegedly discriminated against.

The Second Circuit’s opinion can be viewed here.

NEW YORK – Con Edison Development, Inc., a subsidiary of Consolidated Edison, Inc. and one of America’s largest owners and operators of renewable energy infrastructure projects announced today its agreement to acquire a Sempra Energy subsidiary that owns 981 megawatts (MW) AC of operating renewable electric production projects, including its 379 MW AC share of projects that it owns jointly with Con Edison subsidiaries, and its development rights for solar production and battery storage projects. The purchase price for the acquisition is $1.54 billion (subject to closing adjustments, including working capital). The acquisition is expected to be completed near the end of 2018.

The Troutman Sanders team advising Con Edison was led by Capital Projects partner Craig Kline with support from Robert SchmickerVaughn Morrison and Felicia Xu. Additional support was provided by, among others, Daniel Anziska (Antitrust), Mason Bayler (Corporate), Carl Bivens and Michael L. Warwick (Real Estate), Jonathan Boyles (ERISA), Amie ColbyStuart Caplan and Jessica Lynch (FERC), Angela Levin and Morgan Gerard (Environmental), Roger Reigner (Tax) and James Schutz (IP).

Detailed information about the transaction can be found here.

On August 24, 2018, the Rhode Island Public Utilities Commission (“PUC”) adopted an amended settlement in the Narragansett Electric Company (“National Grid”) rate case. The approved plan provides for an annual step increase over three years resulting in a cumulative $28.9 million rate increase for electric operations and a cumulative $17.4 million rate increase for gas operations. The Rhode Island PUC approved several Power Sector Transformation, Vision and Implementation Plan (“PST Plan”) initiatives proposed by National Grid. This suite of foundational investments will kickstart an initial ramp up of efforts towards meeting Rhode Island policy objectives of (1) grid resiliency, (2) grid efficiency, and (3) distributed energy resource (“DER”) integration. The settlement provides for the following PST initiatives:

  • Foundational Grid Modernization Investments and Grid Modernization Plan: In addition to strategic grid investments to improve reliability and resiliency, National Grid will engage with stakeholders via the PST Advisory Group to develop a comprehensive Grid Modernization Plan
  • Electric Transportation Program: Includes: (i) Off-Peak Charging 6 Rebate Pilot; (ii) Charging Station Demonstration Program; (iii) Discount Pilot for 7 Direct Current Fast Charging (DCFC) Station Accounts; (iv) fleet advisory 8 services; and (v) Electric Transportation Initiative Evaluation
  • Energy Storage Program: Includes behind the meter and facing energy storage projects
  • Performance Based Incentives: National Grid will implement seven incentive mechanisms to advance state policy goals and drive benefits for Rhode Island customers

The PST Plan was developed at the direction of Rhode Island Governor Gina Raimondo. Governor Raimondo asked the PUC, the Rhode Island Office of Energy Resources and the Rhode Island Division of Public Utilities and Carriers to establish a new regulatory framework that will enable the state and its utilities to advance a cleaner, more affordable and reliable energy system for the 21st century.

The amended settlement culminates a comprehensive investigation with robust stakeholder input and participation: stakeholders participated early in the process and the settlement establishes an ongoing framework for stakeholders to develop additional measures over the next three years. Rhode Island PUC Administrator Macky McCleary said that “[t]oday’s PUC order is another significant step in Rhode Island’s journey to modernize the electric grid, so our residents, businesses, and communities can benefit from cleaner, lower-cost energy resources.”

Rhode Island joins California, New York, and Hawaii in leading the charge toward comprehensive grid modernization. The comprehensive and coordinated approach employed by Rhode Island proved successful in obtaining PUC approval.

On July 27, 2018, the U.S. Court of Appeals for the Federal Circuit issued an opinion reversing the decision of the Court of Federal Claims in Alta Wind I Owner-Lessor C, et al. v. U.S. The Federal Circuit held that goodwill and going concern value could attach to the assets of wind facilities that had not yet been placed in service and therefore that the Code Section 1060 residual method of allocating purchase price applied to the acquisition of the wind facilities. The Federal Circuit’s holding that goodwill and going concern value can attach to a wind facility, and the fact that it vacated the decision of the Court of Federal Claims (which included other holdings favorable to industry participants) could have significant implications for renewable projects.

At issue in Alta Wind was the appropriate amount of cash grants pursuant to Section 1603 of the American Recovery and Reimbursement Act of 2009 for several wind facilities. The Alta Wind plaintiffs purchased wind farms from a developer, placed them in service, and then applied to the Treasury Department for $703 million in Section 1603 grants. The Treasury Department awarded Section 1603 grants of approximately $495 million based on a determination that a portion of the purchase price for the wind facilities should be allocated to intangibles, potentially including going concern value and goodwill, using the residual method under Section 1060 of the Code.

As explained in our prior analysis, the Court of Federal Claims had focused on whether the wind farm acquisitions qualified as “applicable asset acquisitions” under Code section 1060 because of the presence of goodwill or going concern value. The court found as a matter of fact that neither goodwill nor going concern value could exist for a non-operational plant and therefore held that Section 1060 of the Code did not apply. With respect to goodwill, the court ruled that prior to beginning operations, no “expectation of continued patronage” could possibly exist under the terms of the PPAs, which is the sine qua non of a finding of the existence of goodwill. Regarding going concern value, the court cited United States v. Cornish, 348 F.2d 175 (9th Cir. 1965) for the proposition that going concern value, as distinguished from goodwill, is the “special value inherent in a functioning plant continuing to do business and to earn money with its staff and personnel.” Since the wind farms at issue were not functional at the time of acquisition, the court found that no separate intangible going concern value had yet been created. The Court of Federal Claims also held that location value, turnkey value, and any value attributable to above-market PPAs were inherent in the tangible property rather than separate intangibles.

The Federal Circuit disagreed with the Court of Federal Claims after applying a strict reading of the regulations under Section 1060 of the Code, which state that a group of assets constitute a trade or business requiring the use of the residual method if the “character” of the group of assets transferred is such that goodwill or going concern value could attach under any circumstances. Reg. 1.1060-1(b)(2)(i)(B) (emphasis supplied). According to the Federal Circuit, “[t]here is no need to show that a transaction had actual, accrued goodwill or going concern value at the time of the transaction” for the residual method to apply.

The Federal Circuit’s decision appears to leave open the debate as to whether a plant-specific, non-transferable power purchase agreement is an intangible asset separate and distinct from its underlying renewable energy facility. In 2012 the IRS issued PLR 201214007, in which it ruled that a facility-specific PPA was not separate from the underlying facility, citing a similar rule under Code section 168(c) for commercial real estate. The IRS subsequently revoked that ruling in PLR 201249013. The Federal Circuit addressed this issue in its analysis concerning one of the factors that could indicate the presence of goodwill and going concern value—viz., the presence of intangibles associated with the tangible property. Without much analysis, the court concludes that “the PPAs, or at least some portion thereof, may be characterized as customer-based intangibles” under Section 197 of the Code and accordingly appears to conclude that PPAs, or portions of the PPAs, could be separate intangibles. However, the court completely failed to address the substantive legal arguments for and against a holding that a facility-specific PPA is a separate and distinct asset from the underlying facility. If the Federal Circuit’s opinion can be confined to the initial determination of whether the residual method applies to a non-operational plant with a PPA, then the substantive issue of whether, as a matter of law, any value should be associated with an in-the-money PPA, or whether that value is inextricably intertwined with the value of the facility’s tangible asset, arguably remains to be decided another day.

The Federal Circuit opinion is a significant setback for industry participants in their attempts to assert that virtually all the basis in wind and solar projects is attributable to the tangible property, just as the trial court opinion was a significant setback for the government. However, it remains possible that the Court of Federal Claims on remand could conclude that there is in fact no goodwill or going concern value associated with the wind facilities, and we expect industry participants to take a similar position in the meantime.

Federal Energy Regulatory Commission (“FERC”) members on June 19, 2018, affirmed their commitment to regional energy market stability. Their remarks came in response to a leaked Trump administration draft plan and President Trump’s own June 1, 2018 public statement that Secretary of Energy Rick Perry “take immediate steps” to prevent coal and nuclear plant closures.

Such a directive could mean a policy of requiring regional grid operators to buy electricity from selected coal and nuclear plants, which, in turn, could undermine the current power markets developed with FERC assistance over recent decades. “Avoidance of any significant distortion in organized markets would very much be a concern of ours that we would keep an eye on as we proceeded with the rate matter,” said FERC Chairman Kevin McIntyre in response to a leaked draft plan from the White House. “I don’t see any reason why any of that should interfere with our ongoing consideration of the grid resilience issues and the very good input we’ve gotten on those issues.” Continue Reading White House Memo May Indicate Future Coal and Nuclear Subsidies