This post is part of an occasional series highlighting a project finance article or news item from the past. It is often interesting and thought provoking to look back on these items with the perspective of months, years or decades of further experience.
With this installment, we turn to an article that was published in the Project Finance Newswire in November 2012 and written by Kenneth Hansen, a partner in our Project Finance Group.
Feed-In Tariff Insurance
The Overseas Private Investment Corporation is offering to insure projects against loss of income as a result of a government reducing or abrogating a feed-in tariff.OPIC is a US government agency that provides financing and political risk insurance to promote US investment in emerging markets.
Many governments encourage construction of wind, solar, geothermal and other renewable energy projects by paying more for electricity from renewables than from other sources. These higher payments are called feed-in tariffs.
The new insurance coverage will not be available to support investments in countries like Spain, where the government’s unwinding of its feed-in tariff program has triggered headlines and investor lawsuits. Notwithstanding current European economic woes, Spain, Portugal and Greece are all too wealthy for OPIC’s programs, which focus on encouraging investments in low- and middle-income countries. However, the new OPIC product could prove useful to investors in the dozens of emerging markets that have enacted feed-in tariff programs to encourage the development of renewable energy projects.
OPIC has circulated for comment a preliminary draft form of insurance policy. That form embeds the new coverage in an enhanced version of its traditional expropriation coverage, but expands the traditional scope in ways renewable energy project developers are likely to find useful.
It provides five distinct bases for a claim.
A claim may made on the policy for the business income lost as a result of a feed-in tariff being reduced.
A claim may be made for a complete loss of the project as a result of a reduction or termination of a feed-in tariff.
The tariff reduction may be in substance a creeping expropriation of the project, which could be a separate basis for a claim.
Many power contracts require that disputes go to arbitration. A claim may be made if the project wins an arbitration award, but the government fails to pay.
Finally, a claim may be made if the government refuses to go to arbitration or otherwise frustrates the arbitration process.
The first two bases for claims are new and focused on projects supported by a feed-in tariff. The last three are conventional political risk insurance coverages.
Lost FIT income
Coverage for lost business income provides that, if a government reduces a feed-in tariff from the level promised in a power purchase agreement without “prompt, adequate and effective compensation,” and if those circumstances remain unremedied for at least six months, then OPIC will compensate the project for most of the lost revenue.Specifically, OPIC will pay the investor’s share (i.e., the insured investor’s percentage ownership interest in the project company) of the shortfall in revenue attributable to the reduced feed-in tariff, up to the lesser of two amounts. One is the aggregate shortfall over an agreed period (suggested to be 12 to 24 months). Another is 90% of the investor’s share of the book value of the project company. Payments under the policy are also subject to an overall cap.
For this purpose, the “government” includes any of its legislative, executive or judicial branches, a regulatory authority charged with setting the feed-in tariff or a government-owned utility that is purchasing the electricity.
Confiscatory FIT reduction
OPIC offers a distinct element of its coverage where the reduction of the feed-in tariff causes losses so severe that the insured investor writes off its investment in the project company.In that case, OPIC would pay up to 90% of the investor’s share of the project company’s book value. This is the same measure of compensation that would apply if the project company were expropriated by the government.
This coverage excludes claims arising from disputes under project agreements, which are relegated to the arbitration coverages (discussed below). The straightforward case for a confiscatory feed-in tariff reduction claim would arise where a government-owned utility that is buying the electricity fails to pay the feed-in tariff rate that it clearly owes under the power purchase agreement.
To be sure, a government may not freely admit that its actions breached, or caused a breach of, a power purchase agreement. More likely is that the government would at least assert some basis for a dispute. If, for instance, suspension of the feed-in tariff is implemented by a change in law, the situation could be interpreted as a dispute over proper interpretation of the power purchase agreement, which is likely to contain a provision requiring the agreement to be performed in compliance with applicable law. The investor, on the other hand, is likely to feel, and to assert, that the contract is clear and that the government is simply in breach, whether or not a change in law caused that breach.
In such circumstances, OPIC might accept a claim for confiscatory feed-in tariff reduction or, instead, it might find grounds in the insurance contract to require the investor first to pursue arbitration against the utility. To accept a confiscatory feed-in tariff reduction claim, OPIC will need to conclude that the government’s claim of a legitimate dispute is without merit.
The draft insurance policy complements the lost feed-in tariff income and confiscatory feed-in tariff reduction coverages with OPIC’s traditional coverage for total expropriation of the project as well as somewhat less traditional, but nonetheless well-established, coverages for the government’s failure to pay an arbitral award and for its frustration of the arbitration process.
General expropriation
The feed-in tariff coverage package will include at no extra charge OPIC’s traditional coverage against loss from expropriation of the project.An expropriation claim will not require a breach of the power purchase agreement but rather one of two things. Expropriation can be established by showing there was “an outright taking of the insured investment” or that government acts have the effect of taking the project. An effective taking means acts that “deprive the Investor of its fundamental rights or prevent, unreasonably interfere with, or unduly delay effective enjoyment of the Investor’s fundamental rights in the Insured Investment.” Rights are “fundamental” if, without them, “the Investor is substantially deprived of the benefits of the Insured Investment.”
Under the general expropriation coverage, an insured loss must be total. Nothing in the description of the scope of the general expropriation coverage says so, but that nonetheless is OPIC’s clear intent.
First, the general expropriation coverage is provided under the heading of “total expropriation.” More substantively, in order to receive a claim payment, the investor is required to “transfer to OPIC all interests attributable to the Insured Investment, including without limitation, shares in the Foreign Enterprise.” Doing that only makes sense if the value of the investment has been totally, or nearly totally, lost. Finally, the basis of compensation for a claim is the investor’s share of the total book value of the insured investment. In contrast to the confiscatory FIT reduction, the general expropriation terms do not require the investor to have written off its investment. However, a claim under the general expropriation coverage does require that the government’s acts have had the effect of “taking” the insured investment, in which case applicable accounting standards will likely have required that write-off.
Arguably, the protection afforded by the confiscatory feed-in tariff reduction coverage is already substantially available under the general expropriation coverage (as well as under OPIC’s conventional expropriation coverage). If the requirements for a confiscatory feed-in tariff reduction claim (indirect taking that breaches the power purchase agreement plus a failure to pay prompt adequate and effective compensation) are met, then the requirements for a general expropriation (non-compensation and an effective taking without any requirement for a related power purchase agreement breach) will necessarily have been met. A claim under either coverage triggers identical compensation. The assignment obligations to OPIC are also identical.
However, there is a clear advantage in claiming a confiscatory feed-in tariff reduction — rather than general expropriation — when it comes to the process for proving the validity of a claim.
For an expropriation claim, OPIC traditionally required proof of, among other things, government acts that violated international law. For years clients complained that they were unclear as to exactly what sort of government behavior might be required. For its part, OPIC was concerned that non-expropriatory violations of international law that cause economic harm — for example, war crimes that did not specifically target the investor’s facility — might inadvertently satisfy the designated requirements for a claim. OPIC revised its policy language to replace the international law violation requirement with distinct conditions that, if satisfied, were sufficient to assure the existence of such a violation — one tied more directly with expropriatory behavior by a government. Those conditions, which the draft insurance policy provides as requirements for a general expropriation claim, include a direct or indirect taking of the insured investment and the absence of prompt adequate effective compensation. Those elements together suffice to establish that the taking is illegal under customary international law.
The presence or absence of compensation will typically be clear. Whether a taking has occurred can be less so.
Creeping expropriation (i.e., an indirect taking through the effects of assorted government actions) may be difficult to prove. The difference between a malicious, discriminatory taking and the imposition of an innovative regulatory regime can be in the eye of the beholder. Indeed, it was the challenge of proving that a government’s actions went beyond what international law permitted that made some OPIC clients nervous under the traditional policy language requiring an international law violation. That challenge remains under the new policy. The new language just focuses the challenge on proving a taking by the government.
The language for confiscatory feed-in tariff reduction coverage provides the aggrieved investor a helping hand. In addition to requiring a taking, it also specifies what is necessary to prove that a taking has occurred. It requires government acts (“through generally applicable official legislative or administrative action or other regulatory decree”) that have “the effect of taking the Insured Investment in that the resulting business income loss to the Foreign Enterprise is so material that it adversely affects the commercial viability of the Project and causes a write-off of the Investment on the Investor’s financial statements.” For a compensable claim, these circumstances must also be without prompt, adequate and effective compensation and constitute a breach under the power purchase agreement, though it is difficult to imagine how such a taking of the project could fail to breach the PPA.
By specifying these necessary conditions, the confiscatory feed-in tariff reduction coverage provides a clear standard for proving such an indirect taking. If a government reduces its feed-in tariff, and that action both breaches the power purchase agreement and undermines the commercial viability of the project, then the key requirements for a claim will have been satisfied without having to argue that the government’s actions were not reasonable regulatory measures. This could provide a shorter, clearer route to a successful claim than under the general expropriation coverage.
Nonpayment of arbitral award
If a feed-in tariff were reduced and, as a result, the project company were to bring, and win, an arbitration against a government utility or a government guarantor for breach of a project agreement, and if the award were not paid, then OPIC would pay the award. The project company would have to assign its claim against the government to OPIC. OPIC then would seek enforcement of that award against the governmental party responsible to pay it.This coverage can stand behind arbitration of disputes under any project agreement, including the power purchase agreement, and provides that OPIC will pay “the Investor’s Share of the Award” if the government fails to do so after a waiting period. As drafted, the policy suggests that the coverage is intended only for disputes over government behavior that has destroyed the full value of the insured investment. However, OPIC has indicated that the current plan is for the arbitration coverage to be effective against unpaid arbitral awards of any size.
While compensation for an unpaid arbitral award is capped at the book value of the insured investment, it is not subject to the 12-to-24 month limit that applies to the lost feed-in tariff income coverage. This coverage could, in principle, cover the full value of the lost income for the full term of the power purchase agreement, subject to the compensation not exceeding the investor’s share of the book value of the project company or the overall contractual cap.
Denial of justice
OPIC will also cover arbitration-related losses where a government successfully frustrates attempts to arbitrate a dispute. More specifically, OPIC will pay compensation if, for any six continuous months during an 18-month period during which the project company (referred to in the policy as the “Foreign Enterprise”) is attempting to avail itself of the agreed dispute resolution mechanism, the governmenteither (1) frustrates, obstructs, thwarts, or denies the Foreign Enterprise’s reasonable efforts to bring the Dispute Resolution Procedure to a [final award] (other than by means of defending against the Foreign Enterprise’s claims in accordance with the rules governing the Dispute Resolution Procedure), or (2) renders such reasonable efforts impossible or exceptionally hazardous to the physical safety of representatives of the Investor, the Subsidiaries, or the Foreign Enterprise.
The policy provides that the compensation will be the investor’s share of the book value of the project company, so that this coverage would only be relevant where the relevant dispute has led to “termination of the Project.” The investor would have to assign OPIC its rights against the government under the relevant project agreement. Then OPIC, or the investor on OPIC’s behalf, could continue the arbitration process or settle the dispute. Although the drafted coverage focuses on disputes that have led to termination of the project and compensation equal to the investor’s share of the project company’s book value, OPIC is open to also covering less-than-complete disaster scenarios. Such claims would be paid in exchange for an assignment to OPIC of the arbitration award.
Exclusions and limitations
OPIC is excused from paying under each of these coverages if [t]he preponderant cause of the [loss] is (i) actions related to the Project, other than actions taken in the ordinary course of business, attributable to the Investor or the [project company], or the controlling equity holder of the [project company], or (ii) violations of Corrupt Practices Laws by the Investor or the [project company], or the controlling equity holder of the [project company].OPIC is also excused from paying if the government’s actions are taken pursuant to its lawful authority under licenses, permits, or concessions between [it] and the Investor or the [project company] in connection with the Project.
That is, if the government has the right to do what it did under project-specific contracts or other arrangements such as permits, then OPIC will not compensate the investor for the consequences of the government doing what it had every right to do.
Observations
The new feed-in tariff insurance policy expands OPIC’s traditional expropriation coverages in several ways that should be attractive to investors in renewable energy projects in emerging markets.First, the lost feed-in tariff income coverage, which is in effect a partial expropriation coverage, is completely new and could provide projects a lifeline for survival while feed-in tariff programmatic issues are being worked out or reconsidered by the government.
Second, if the issues lead to a total meltdown of the feed-in tariff program, then investors have an assurance through multiple routes (confiscatory feed-in tariff reduction, general expropriation coverage, arbitral award default or denial of justice) that they will recover the value of their equity investments.
Third, while the draft policy does not yet include coverage for unpaid arbitral awards for less than a full taking of the project, or for frustration of the process that could lead to such awards, such expanded scope should be available to investors who seek it. Therefore, investors should be able to take comfort that, in less-than-total-disaster scenarios, they will be able to collect damages due pursuant to agreed dispute resolution mechanisms.
Finally, the fact of OPIC took the initiative to create this new coverage program suggests that prospective investors in renewable energy projects in emerging markets will find an enthusiastic partner in the US government.
