Shades of green: New Department of Defense renewable energy commitment presents significant opportunities (and risks) for developers

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1 AUGUST 7, 2013 Shades of green: New Department of Defense renewable energy commitment presents significant opportunities (and risks) for developers By Ellen S. Friedman and Tiana Butcher Background The Department of Defense ( DOD ) recently announced a commitment to deploy 3GW of renewable energy projects by The Department of the Army alone anticipates soliciting over 30 solar, wind, biomass/waste-to-energy, and geothermal projects within the next 10 years. These initiatives, driven largely by the National Defense Authorization Act of 2010 s goal of utilizing 25% renewable energy by 2025, are being structured to access private financing, in light of declining DOD budgets, and to utilize specialized private industry expertise. These trends suggest significant future opportunities for private renewable power developers. Interested participants, however, must appreciate and understand the many differences between government contracting and private project development and finance. Contracting with the government involves an adjustment of risk management measures and contract provision expectations. The DOD has proposed the development of renewable energy projects that will be constructed, managed, and funded by third parties. These projects will be on federal land and subject to federal agency oversight with the goal of providing a local and reliable renewable energy resource ( Public Renewable Energy Projects ) to the U.S. military. Using this structure, the DOD would not acquire any generation assets, but would instead purchase some or all of the energy and/or renewable energy certificates generated by these projects. Except as discussed below, the developer would be wholly responsible for developing, financing, designing, constructing, operating, owning, and maintaining the project. We note, that other federal government agencies, including the Department of Energy ( DOE ) are pursuing initiatives designed to spur development of privately owned renewable energy projects on federal lands (see ng/power_purchase_agreements.html).

2 EITF Role and Renewable Energy Services Agreement Template The Army established the Army Energy Initiatives Task Force ( EITF ) in 2011 to centrally manage, coordinate, and implement the development of private renewable energy projects in excess of 10MW on Army installations. EITF has been tasked with the challenging job of developing structures and processes that, on the one hand, satisfy Army base requirements and Federal Acquisition Regulation (FAR) and Defense Acquisition Regulation (DFAR) mandates, and, on the other hand, provide transparency, speed and sufficient profit margins to attract private developers, tax equity investors, and financiers. The EITF has publically identified several specific opportunities for private development (see and has worked together with the U.S. Army Corp of Engineers in rolling out the Army s $7 Billion Renewable Energy Multiple Award Task Order Contract (MATOC) initiative. EITF has also issued several one-off solicitations and requests for information for renewable energy projects outside of the MATOC process, including solicitations for solar projects at Fort Detrick and Fort Irwin and a biomass project at Fort Drum. Each of these initiatives involves a highly competitive bidding process with the government specifying and ranking several evaluation factors, including technical capability, financial capability, prior experience, socio-economic considerations, and pricing. To standardize and streamline the Army s approach to contracting with respect to its solicitations of Public Renewable Energy Projects, EITF has recently drafted a form Renewable Energy Service Agreement Template (the RESA Template ) (See ITF1&pseqnbr=374792&pnot_type=SNOTE) and sought public comment by May 29, EITF is in the process of reviewing the many responses it has received, but has not yet released the comments or responses to the comments for public review. During this interim period, EITF continues to issue solicitations, modeled upon the RESA Template, and requests for information. Developers and financing parties interested in participating in Public Renewable Energy Projects in the future should become familiar with the RESA Template and understand the general form, the many provisions incorporated by means of cross-reference to the FAR and DFAR, and proposed risk allocation contained therein. Our discussion below is based upon the draft RESA Template and its various provisions (including cross-references). These provisions may be subsequently revised by EITF or tailored for specific solicitations. They may also be subject to private negotiation. Answers to certain frequently asked questions relating to the RESA Template and EITF s plans generally can be found at Unique Government Contracting Features To effectively and profitably participate in EITF solicitations and similar future solicitations by the DOD and the DOE, a private developer should take note of the various distinctions between private project development and financing versus project development involving the federal government. While not an exhaustive list, the below points highlight certain of these distinctions and contractual provisions. 2

3 Due Diligence Review Before a solicitation is even released, EITF will have undertaken a rigorous internal project validation process. EITF has stated that each project opportunity in its pipeline is measured against eight different factors: (1) its role in meeting a specific installation s mission and energy security, (2) economic viability, (3) real estate availability, (4) regulatory factors, (5) the amount of power that an installation will be able to off-take from a given project, (6) the utility integration and interconnection requirements for the project, (7) compliance with the National Environmental Policy Act ( NEPA ), and (8) identification of the most suitable project acquisition vehicle. EITF has discussed sharing certain results of its due diligence review, including the results of its NEPA review, with developers in connection with the solicitation process. As demonstrated with the Fort Irwin solicitation, however, many of the developers requests for data, surveys, and Phase 1 results were not addressed prior to the submission date. Although developers have an opportunity to undertake their own due diligence review before submitting a bid, access to the project site itself may be limited prior to award and the timing of the due diligence process will likely be accelerated as may be dictated by a particular competitive solicitation and, in part, based upon the military s initial diligence. The agency maintains oversight over environmental compliance of the project as well. The Fort Irwin project, for example, required that the developer hire a biologist to monitor project activities within the desert tortoise habitat and to locate, protect, and minimize the impact of the project on the desert tortoise. The developer would be responsible for the cost of these environmental compliance efforts. Budget Cuts and Appropriation Risk The DOD has the authority to enter into contracts for the provision of energy for a period of up to 30 years (see 10 U.S.C. 2922a), although a solicitation may provide for a shorter term. The costs of the contract for a particular year must be paid from annual appropriations for that year. A multi-year contract may include language providing that the agency s obligation to make payments under the contract is contingent upon the appropriation of funds. The RESA Template incorporates language that makes the contract contingent upon the availability of funds. In light of recent federal budget reductions, a developer should consider the risk that sufficient funds may not be appropriated for the purchase of renewable energy in future years, especially if the agency intends to adopt an escalating fee schedule where costs are loaded into the final years of the contract. It is unclear how these provisions will be received by the financing community, although similar type provisions exist in many other governmental contracts. Renewable Energy Credits A developer considering a Public Renewable Energy Project must also be mindful of whether the agency intends to retain all renewable energy credits ( RECs ) generated on-site or whether these RECs are available for the developer to sell. Some contracting officers have recognized that a project is easier to finance, thus lowering the ultimate cost to the agency, if the developer is able to sell the RECs generated by the project. In the RESA Template, however, EITF notes that ownership of RECs resulting from the renewable energy generated on-site will remain with the government. 3

4 Contract Termination and Continued Use of Site Procurement regulations and the RESA Template currently provide that, upon termination of the power purchase contract, the developer s leasehold interest in the government s real property is concurrently terminated. Upon termination of the lease, the developer is required, at its sole expense, to remove the project infrastructure and restore the site to its previous condition, including necessary environmental remediation and clean-up. Thus, when determining whether a contract will be financially viable, a developer must consider both a prohibition on project utilization beyond the tenor of the governmental power purchase arrangement and the cost of restoration and remediation. EITF has received and is considering comments that recommend allowing for utilization of the site for third-party power sales following termination of the power purchase arrangements with the military. Absent adjustments, the current RESA Template negatively impacts the developer s financing options and economics. Delays Resulting from Bid Protests. A developer may encounter delays leading up to the contract start date if a bid protest is filed. Bid protests can be filed before an award or generally up to ten days after an award. Competitors can lodge their protests with the agency, the U.S. Government Accountability Office ( GAO ), or the Court of Federal Claims. Performance of a contract is generally stayed during a pending bid protest before the agency or the GAO. While protests before the GAO are subject to an expedited review process, appeals may delay the start of a contract for an uncertain period of time. As noted above, the contract is also subject to agency oversight, which could delay the start of the project. Buy America Provisions The federal government generally prefers the use of domestically sourced construction materials under federal procurement contracts. While the government may make exceptions if the domestic product is unavailable or significantly higher in price, a developer bears the burden of demonstrating that foreign sources should be used and is generally required to support such a request with pricing, product descriptions, delivery estimates, and other justifying data. In contracts with the Department of Defense, including contracts based on the RESA Template, the preference for domestic products extends specifically to photovoltaic devices. If the value of the photovoltaic devices being purchased under the contract is $202,000 or greater, then the Department of Defense will only consider offers utilizing photovoltaic devices that are made in the United States and certain other countries that have reciprocal defense procurement agreements or trade agreements with the United States, which includes Taiwan, South Korea, and Japan but excludes China. A developer should contemplate the impact of such sourcing requirements before responding to a solicitation. Subcontracting A developer must also be mindful of federal contract rules when selecting subcontractors. The government reserves the right to suspend parties from working on federal government contracts for a period of time or to debar them entirely from performing on federal government contracts. Parties that contract with the federal government are generally obligated to ensure that any subcontractors hired to work on a federal government contract have not been suspended, debarred, or proposed for debarment by any executive agency. If a developer desires to enter 4

5 into a subcontract with a suspended or debarred subcontractor, the developer must notify the agency in advance and specify a compelling reason for doing business with this subcontractor. A developer must also be mindful of whether its activities could lead to its own suspension or debarment. For example, a breach of the labor provisions of the RESA Template may be grounds for termination of the contract and for debarment as a contractor with the federal government. A developer may also be debarred if convicted or subject to a civil judgment for the commission of fraud or a criminal offense in connection with obtaining or performing a contract, for violating federal or state antitrust statutes relating to the submission of offers, for making false statements, or for the commission of other offenses that indicate a lack of business integrity or business honesty, among other activities. The government encourages parties in contract with the government to work with small business concerns, veteran-owned small business concerns, service-disabled veteran-owned small business concerns, HUBZone small business concerns (a small business concern that appears on the List of Qualified HUBZone Small Business Concerns maintained by the Small Business Administration), small disadvantaged business concerns, and women-owned small business concerns when choosing subcontractors. For contracts with the DOD, this list also includes historically black colleges and universities and minority institutions. The RESA Template requires that the developer develop and submit a small business subcontracting plan setting forth, among other things, goals for the use of small businesses as subcontractors, the dollars to be set aside to subcontract with various classifications of small businesses and a description of the supplies and services to be subcontracted. A failure to utilize small business concerns or meet the small business subcontracting plan requirements in good faith may result in a material breach of contract by the developer. The subcontracts themselves must be tailored to meet federal requirements. Federal procurement regulations require that certain contract clauses contained in the contract with the agency flow-down to subcontracts. Many other contract clauses in a contract with a federal government agency should flow-down into subcontracts to protect the developer. As a result, all subcontracts should be reviewed to ensure they contain the appropriate terms. Labor Requirements Contracts with the federal government are subject to the Davis-Bacon Act and the Service Contract Act of 1965 that require parties to certain contracts with the government to pay mechanics and laborers a prevailing wage (as defined in the contract) plus overtime equal to 1.5% for more than forty hours of work performed per week and service workers a prevailing wage as well as certain fringe benefits. The Davis-Bacon Act generally applies to contracts with the federal government for construction, alteration, or repair of public buildings and public works. The Service Contract Act of 1965 generally applies to contracts with the federal government involving service employees. The RESA Template noted that developers would be subject to the requirements of both Davis-Bacon and the Service Contract Act. The final EITF contracts may ultimately limit or exclude such requirements if developers and other interested parties are successful in establishing (1) that the construction of a privately owned generation facility on government 5

6 property should not fall within the scope of the Davis Bacon Act and (2) that Service Contract Act of 1965 exclusion relating to contracts for public utility services would be applicable. The Fort Irwin form contract did exclude the Service Contract Act requirements but retained the Davis-Bacon Act requirements for the construction phase of the contract. If solicitations based on the RESA Template continue to include the Davis-Bacon Act and Service Contract Act requirements, a developer should contemplate the impact of these labor requirements when calculating the cost of performance under the contract. Agency Authority to Terminate or Revise the Contract The federal government reserves the right to terminate any federal procurement contract for any or no reason. This is deemed a termination for convenience and is incorporated into all federal procurement contracts. Typically, when a contract is terminated for convenience, a developer is entitled to payment for supplies or services accepted by the government but not yet paid, profit on preparations made and work completed, and reimbursement of reasonable costs incurred, as typically negotiated by the parties after termination. This amount does not typically include anticipatory profits. Under the RESA Template, if termination occurs after the commercial operation date, the developer shall be compensated in accordance with the negotiated termination values set forth on the termination values schedule to the contract. We anticipate that these negotiations will need to address satisfaction of all outstanding project finance debt (including any make-whole or interest rate swap settlement amounts that may become due upon an early termination), tax equity liabilities (including any recapture liability), and compensation of the developer s future expected profits (to be paid on a discounted basis, based upon a negotiated discount rate). The termination values schedule allows the developer to negotiate, in advance, the fees that would make the developer whole upon a termination for convenience. This allows the developer to minimize some of the risk inherent in contracts containing termination for convenience provisions. The government also retains the ability, in many instances, to unilaterally modify a contract through the Changes Clause, although a developer may be eligible to receive compensation for the cost of such changes. In addition, under the RESA Template, the government retains the right to purchase the project at any time on an as-is basis at a price equal to the greater of the project s fair market value or the then outstanding balance of any project financing, secured by the lien of the project. In the Fort Irwin project, the government still retained a similar purchase option; however, the option only becomes available to the government six years after the project s commercial operation date. Presumably, this change was made in recognition of the fact that renewable energy projects currently benefit from the investment tax credit. By deferring the government s purchase option, a tax credit recapture event is likely avoided. The existence of such purchase option must be taken into account in connection with project equity and debt arrangements. A developer must price its bid accurately, while taking into account the types of risks and government mandates described above. The provisions cited above are merely an introduction to the federal procurement contracting provisions. We expect that the terms of 6

7 the RESA Template will evolve as EITF works with industry to ensure the projects are feasible and financeable. We stand ready to help you navigate this process and take advantage of these exciting opportunities! Ellen S. Friedman at (212) or Tiana Butcher (202) or 7