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The New Green Finance
The best way to tap into renewable project funding.
state regulations often make it much more difficult for such subsidiaries to operate effectively in the utilities’ home markets, particularly in franchised service territories.
Developers and utilities can achieve their respective goals of limited liability and rate recovery through a joint-ownership structure known as a “tenancy in common.” As tenants in common, a developer and utility each would own an undivided percentage interest in the project assets, with the interest allocation determined by the parties. They would hold their ownership interests through vehicles that achieve their respective goals: The developer would own its portion of the project assets through a special-purpose entity that limits its liability and allows for non-recourse project financing, while the utility would own its portion directly and thus preserve its ability to recover project costs from its ratepayers. Thus if a utility wishes to receive bids for joint ventures, it should ask developers to draft their proposals under a tenancy-in-common structure.
When a large, creditworthy utility partners with a developer, the utility risks exposing itself to a larger share of liability than its proportionate ownership unless the utility obtains security from the developer or limits its liability by contract. Many developers are small companies with shallow pockets. Even if a developer is a large, established company, it won’t be entitled to rate recovery, a right that contributes significantly to a utility’s creditworthiness. Further, if the developer holds its ownership interest through a special-purpose entity, the developer’s upstream liability will be limited. A regulated utility investing directly in a project lacks similar means of limiting its liability: If the utility is required to own its interest in the assets directly for regulatory purposes, the utility risks becoming a deep pocket in its joint venture.
A utility can mitigate this risk by requiring its developer partner to post security that narrows the disparity between utility and developer. Among other alternatives, such security can take the form of insurance, a guaranty from a creditworthy parent, a security interest in assets owned by the developer’s project company, or a letter of credit. When calibrating the appropriate level of security, the utility should consider what levels of security are appropriate at different stages of the project’s development and how much a security requirement will discourage bids or increase a project’s costs. Asking bidders to include the cost of different types of security as separate line items in their proposals will facilitate the utility’s evaluation of the market cost of credit support.
To some extent, a utility and developer can limit the need for backstop financial security by providing in their third-party contracts that their project liabilities will be several and not joint. Thus a contractual counterparty to the joint venture couldn’t sue just the utility for the entire amount of its claim, but instead would need to pursue each joint venturer for its proportionate share. Although this contractual division of liability has an attractive logic, it might be unrealistic in practice. Some contractual counterparties of the joint venture, such as an EPC (engineering, procurement and construction) contractor or turbine supplier, might refuse to