Joint arrangements to develop renewable energy projects
There is no cookie-cutter joint venture or joint development arrangement.
Each party brings different industry expertise, capital and motivations going into the relationship.
A number of questions should be answered at the outset. What is the end goal? Why enter into a joint arrangement? What does each bring to the table? Do the parties plan jointly to develop a number of projects that one of the parties will own after development has been completed? Or is the goal for the parties to own projects jointly with a view to sell later to a third party? Each joint venture requires a different approach.
Joint Development Agreement
A joint development agreement allocates development responsibilities and explains how the project costs will be paid.
A common pattern is a developer with the experience to develop solar or wind projects, but without the means to post credit support for interconnection requests, safe-harbored equipment or offtake arrangements, enters into a joint development agreement with someone with money.
The first issue they face is how much control the money party should have over development decisions. The money party will certainly want information and access rights, but should consider to what extent it needs approval rights over decisions about how best to develop the project.
Most deals allow the developer to take responsibility for standard development activities with some level of oversight or approval from the money party. Standard activities may include determining the project location and layout, securing real estate and completing title work, obtaining interconnection studies and agreements, and securing local permitting and tax abatements. If both parties have significant development expertise, they may split the activities between them, or perhaps one party may have more financing expertise and take the lead on financing for the project. In scenarios where a utility or other participant in the power industry without significant renewable energy expertise is involved, it may take the lead on offtake arrangements, interconnection and community outreach, leaving the rest for the developer.
The next step is to focus on how project risks are shared. Risk generally should flow from responsibility.
The joint development agreement should also address the standard of care. Development is an inherently uncertain business, so the developer cannot guarantee success. A prudent-industry-practices standard is normally used.
Some collaborations are structured with only a joint development agreement between the parties. In these deals, only one party owns the project at any given time. Many such deals then contemplate the project will be transferred to the other party once a milestone is hit.
This type of arrangement is common in situations where a utility or private equity fund has money and wants to own projects, but lacks the skills to seed projects. In this situation, the parties can arrange a framework-type structure whereby the developer brings a project or portfolio of projects to the table, the parties participate jointly in development pursuant to the joint development agreement, and then the utility or private equity fund ultimately acquires the projects. In this scenario, the parties should consider attaching the form of purchase and sale agreement to the joint development agreement. The purchase and sale agreement will list “conditions precedent” to signing and closing of the acquisition, as well as standard M&A concepts such as timing, a milestone payment schedule, representations and warranties, and indemnities. The parties should also address any additional services that the developer should continue to provide after the project has been sold. These are sometimes put in a separate development services agreement.
A single owner model is simplest. However, in some cases, both parties need to remain as owners. For example, this may be required for tax reasons where one party has stockpiled equipment that can be used as a basis for claiming federal tax credits on a project and the other has the project. The party contributing the stockpiled equipment must retain at least a 21% interest in partnership capital or profits. Joint ownership will be required.
If joint ownership is desired, then the parties usually form a limited liability company to own the project. It may own the project directly or through another LLC subsidiary. It is generally best to use a Delaware limited liability company.
The joint venture agreement allocates responsibilities and the obligation to fund project costs and addresses governance and how revenues will be shared. In some cases, there may also be a joint development agreement with more detail about the roles of the parties during development to avoid cluttering the joint venture operating agreement with this type of detail.
Governance will be crucial for the long-term health of the relationship. Some decisions require agreement by both parties. In many deals, a board of directors is created so that each party can have more than one individual involved in voting on key matters. Not all joint ventures are 50-50. In such cases, some decisions may require a super-majority vote to prevent the majority owner from making all the decisions.
At a minimum, a super majority is required for any change in the rights of the minority owner and for affiliate transactions between the joint venture and the majority owner. In some deals, the unaffiliated partner gets to make decisions on behalf of the joint venture about whether to enter into a contract with a partner or enforce rights or pursue remedies under such a contract.
The creation of a new class or category of member, and the issuance of additional equity interests in the joint venture, may also require minority protections if such a decision would unfairly dilute the minority member. The minority should also have a right to key information such as financial statements.
As the minority owner’s interest gets closer to 50%, the number of decisions in which it has approval rights should increase. A list of “major decisions” that require minority consent is a focal point of negotiations. The list usually includes the budget, issuance of capital calls, borrowing, project and significant asset sales, entering into, amending or terminating material contracts, and declaring bankruptcy or insolvency.
If whole projects are being contributed by one of the parties to the joint venture, then a separate contribution agreement may be needed in order to address project-related representations and warranties and associated indemnities to be given by the party contributing the projects.
If the joint venture arrangement will cover multiple projects to be developed over time, then the joint venture agreement is more likely to take the form of a framework-type structure where additional projects may be added as certain predetermined development criteria are met. The parties should discuss the process by which one party presents a project for the other’s review and approval and whether the economic sharing ratios remain fixed for all projects and, if not, how they will adjust as more projects are added. Will the money party contribute cash to match the contribution of the project, and how will the project be valued? Does the money party have the right to reject the project?
The parties will need to balance the desire to move quickly in order to lock up project opportunities, procure safe-harbored equipment or secure an interconnection queue position against the need to perform thorough due diligence. Once credit support is posted or significant capital is deployed, it may be difficult to unwind arrangements if a project turns out to be untenable.
The joint venture agreement should address how future capital requirements will be handled. Will the joint venture take on debt to finance the project? What obligations will the parties have to contribute cash initially and over time? If one party defaults on its contribution obligations, will the other party have the opportunity to dilute the defaulting party’s interests? The answers to these questions may affect how cash flow is distributed once the project is in operation.
There are many options for sharing cash.
One approach is a simple fixed ratio based on the value of the contributions each party made to the joint venture. If one party then has to fund additional money, it may be entitled to preferred distributions. The parties will need to agree on how to value non-cash contributions.
It is uncommon for a project to remain jointly owned after it has been built. The project is usually sold to a third party or to one of the joint venture partners.
The parties may want flexibility. They may not know exactly how the end game should look when the joint venture is being structured. In such cases, they may agree to a right of first refusal or a right of first offer for one of the parties to buy the other partner’s interest in the project. A right of first offer may be preferable, as a right of first refusal can sometimes scare off other buyers who do not want to spend time negotiating a deal, only to have the ROFR entity come in at the last minute and match. If the joint venture plans a portfolio of projects, one project company could be purchased while the others stay under the joint venture.
Here again, it is a good idea to attach a form of membership interest purchase agreement, purchase and sale agreement or build-own-transfer agreement to the joint venture agreement as an exhibit. This may be a simple agreement assigning LLC interests or it may contain representations, warranties and indemnities. Any conditions precedent to closing should also be addressed.
When the sale is of a project company by the joint venture to one of the partners, a comprehensive package of development representations and warranties may not make sense. If one party was primarily responsible for development activities, should it be on the hook for all liabilities from breach of any development-related representations? A third party buying the project company will not want to get in the middle of a dispute between the two joint venture partners. It will want representations and indemnity from the joint venture. It may want the joint partners to have joint and several liability, meaning it can go after either for the full amount owed.
Joint venture partners do not always consider these issues when the joint venture is formed and instead wait until a sale is imminent. These types of negotiations between joint venture partners may slow down the sale process.
Transfers and Competition
Joint venture agreements usually limit the ability of the partners to transfer their interests.
The restrictions may extend upstream to changes in control. There may be drag-along rights or tag-along rights. A drag-along provision may give a majority partner looking to sell its interest in the joint venture the right to drag minority partners into the transaction, thus making it easier to sell the entire joint venture without consent. A tag-along provision may give one partner the right to tag along and sell its own interest on the same terms and conditions as the other partner negotiating a sale.
These types of provisions work alongside rights of first refusal and rights of first offer. They provide more ways to exit the ?joint venture.
Another issue to address is to what extent the joint venture relationship should be exclusive within a certain geographic region or with respect to the development of certain projects.
It may be appropriate to restrict a developer partner from competing directly with a joint venture project. For example, a nearby project could cause transmission congestion. A nearby wind project could impede air flow and reduce output. Neighboring projects may also compete for offtake arrangements.
Larger developers with an active development pipeline may find a non-competition provision untenable. On the other hand, larger developers are less likely to enter into joint ventures because they lack neither development expertise nor capital.
Defaults and Disputes
The joint venture agreement should address what happens when something goes wrong.
In many contracts, when one party materially breaches the agreement, the other party has the right to terminate. However, a joint venture partner cannot be kicked out so easily because it paid for its ownership interest. Therefore, material defaults usually lead to voting rights being taken away. The defaulting partner retains its economic interest in the company, but no longer has a say in management.
Since a typical joint venture will have multiple agreements including a contribution agreement, a joint development agreement and an LLC agreement, the parties should consider to what extent an event of default under one agreement will cause a default under other agreements. For example, if a partner fails to make contributions under the contribution agreement, will this trigger remedies under the LLC agreement? Perhaps such a breach may lead to dilution of the defaulting partner’s interest. Joint ventures usually only terminate when the parties are ready to wind up and dissolve the business.
There should be procedures for resolving disputes. The dispute may be inability to agree on something material to the business.
Joint venture agreements usually require senior executives of the partners to try to work out the disagreement first. The dispute moves up to more senior management as a first step. How many rounds of executive negotiations and the timeline for such negotiations should be considered based on the expected project timelines.
If the parties still remain deadlocked, then one partner may have a put to force the other to buy it out. Partner A could have a right to offer to sell A’s interest to partner B for an offer price and then be required to buy out B’s interest at that price if B does not buy A’s interest. (This assumes both have equivalent interests.) Alternatively in the event of deadlock, both partners could be required to sell their interests to a third party.
Deadlock provisions should create a situation that would be quick and painful if exercised. If the parties agree to a worst case scenario that both parties would prefer to avoid, then they will have an incentive to resolve disputes quickly and avoid deadlock.