Project sales still closing despite circumvention risk
Sales of solar projects and solar development platforms are still closing, despite some risk that a court could still block implementation of a 24-month moratorium on anti-circumvention duties on solar panels imported from Vietnam, Malaysia, Thailand and Cambodia.
The four Southeast Asian countries accounted last year for roughly 80% of US solar panel imports.
While panel suppliers are getting creative with deferred milestone payments and tariff thresholds, most are unwilling or unable to take the tariff risk.
The result is that US solar developers end up in most cases with the risk and when they try selling projects or project pipelines with such risk, some developers are taking an immediate reduction in enterprise value, but most are taking a wait-and-see approach by introducing earnouts or other deferred payment structures into the purchase agreement.
The uncertainty created by the Commerce Department investigation into whether Chinese panel suppliers are circumventing duties that would apply to direct imports from China is creating unique legal issues for buyers and sellers to beware of when entering into purchase and sale agreements and solar panel procurement contracts.
The potential duties vary depending on the panel supplier. They are the same duties that would apply if the particular panels were imported directly from China. The US is currently collecting a China-wide anti-dumping duty of 238.95% and countervailing duty of 17.1% on Chinese solar panels imported, but many manufacturers qualify for lower rates after presenting evidence to Commerce of their actual dumping margins and government subsidies. (For more information, see “Solar Panel Import Duties” in the March 2022 NewsWire.)
Commerce has until August 29 to make a preliminary decision on circumvention and until April 3, 2023 to make a final decision.
President Biden authorized Commerce in a proclamation on June 6 not to collect any anti-circumvention duties for the next 24 months to give solar developers and panel suppliers time to adjust supply chains. The Commerce Department is expected to issue regulations implementing the moratorium in June.
Before the Biden proclamation, there was a risk that duties would be imposed retroactively on panels entering the US as far back as last November 4. The proclamation talked about a bridge period with no duties for 24 months starting on June 6.
Sellers of projects and development platforms are having to balance the desire to get full value from the sale of their projects or companies against the desire to receive the consideration promptly after closing.
If Commerce finds circumvention, the final duties will not be known for years to come. April 3 next year is the deadline for a final decision on circumvention, but Commerce revisits the duty amounts over time. For example, in its most recent review, it reached conclusions about the preliminary subsidies from which various Chinese suppliers benefited on panels imported during the period December 2019 through November 2020 and preliminary dumping margins for calendar year 2019.
Importers post cash deposits. The deposit amounts are adjusted years later after the final duties are known and the deposits are liquidated.
We have seen anti-dumping and countervailing earnouts take various forms. Project or platform sellers who are able to get buyers to consider the overall impact of any potential duties on the value of the project or target company seem in the best position to maximize the sales price.
Parties should be aware that Commerce may find circumvention in one country and not another. It may also place lower duties on imports from one country versus another. Finally, individual suppliers may receive exemptions entitling them to lower duties than the country-wide rate.
The preliminary rates, if any, may differ from the final rates. Therefore, focusing too much on the preliminary rates or the anti-dumping and countervailing duties applied at the country-wide level may result in an earnout that is not representative of the overall impact to enterprise value.
Representations and Warranties
It is difficult, if not impossible, to make any representations and warranties about the current state of solar project schedules, accuracy of project budgets, and even defaults or threatened defaults related to supply or construction agreements. Sellers who agree to such representations risk providing an unintended insurance policy to buyers.
Sellers should not make representations about project schedules or costs. Industry data suggests a large percentage of projects are unable to maintain construction schedules due to tangled supply chains and labor shortages. Some projects lately are costing more to construct than they are worth at the end of construction, due to rising construction costs.
Solar panel suppliers from the affected countries have paused shipments. This created uncertainty about whether developers would be able to obtain panels in time to meet project deadlines. Because there is significant uncertainty about whether duties will be assessed, it is also difficult to give representations about whether current project budgets are accurate.
Some sellers try to exclude the impact of any changes to anti-dumping duties and countervailing duties from representations and warranties.
Some sellers give representations about the project schedule or budget, but qualify them by current knowledge. In such cases, the sellers should be careful to ensure that any conversations they had with their outside counsel about the Commerce investigation remain privileged. Even though these conversations and findings may be protected by attorney-client privilege when given, depending on the deal structure, the privilege may not belong to the seller and, following closing, the privilege rights may be transferred to the buyer.
Sellers should also carefully review governing law with counsel to limit the buyer’s ability to “sandbag” the seller, or else include anti-sandbagging language in the purchase and sale agreement, which is uncommon in M&A transactions. “Sandbagging” is where a buyer has knowledge of a breach of a seller representation or warranty before closing, but closes on the transaction and brings a post-closing indemnity claim for the breach.
Material Adverse Effect
Sellers should also exclude the anti-circumvention investigation and any impact on the project or company from the definition of “material adverse effect.” A buyer can usually walk away from the sale if some event has a material adverse effect on the economic prospects of the project or company.
Not only could a buyer argue that the investigation (or a potential or actual positive finding from the investigation) results in a material adverse effect, but it could also argue there was a breach of seller’s representations and warranties in deals that already closed.
Some buyers may try to use an adverse determination by Commerce on circumvention as a reason to be excused from their obligations to close even in cases where the buyer was on notice of the investigation when the documents were signed.
While changes to general economic and political conditions are usually excluded from the definition from material adverse effect, they may be considered if the target company or project is disproportionately affected by the changes.
Because any potential duties could vary from supplier to supplier, it is possible for one company to be disproportionately affected compared to its competitors if its panels are subject to higher duties than panels from other suppliers or countries.
Interim Operating Covenants
Sellers should also consider the effect of the anti-circumvention duties on their contractual obligations to conduct the target business or project company “in the ordinary course in accordance with past practices” during the interim period between signing and closing.
Many solar companies are not operating their businesses in the ordinary course in accordance with past practices on account of the Commerce investigation. At minimum, they are having to pause construction work and renegotiate power purchase, build-transfer and equipment procurement contracts.
Although it is not directly related to development of solar facilities, buyers may attempt to rely upon case law related to the response to the COVID-19 pandemic. In AB Stable VIII LLC v. Maps Hotels and Resorts One LLC, a 2020 case in the Delaware chancery court, the parties disputed whether the seller’s actions in response to the COVID-19 pandemic complied with its obligations under a purchase and sale agreement. The chancery court held that the seller was not operating in the ordinary course of business when the seller severely limited operations in light of COVID-19.
Buyers may attempt to argue that changes made to the development plan, schedule or budget to accommodate the ongoing inquiries are not “in the ordinary course” and that seller’s actions have harmed the project and, consequently, seller owes damages to the buyer.
On the other hand, sellers who are unable to meet contractual deadlines because they are unable to timely obtain panels (for example, because a court blocks implementation of the 24-month tariff moratorium, and manufacturers continue to pause shipments) may invoke the force majeure provisions of their agreements to defeat breach claims.
Equipment Procurement Agreements
Due to the limited supply of modules, suppliers who continued to ship were sometimes successful in shifting tariff risk to sponsors.
Whether as part of the diligence process in an M&A deal, or as part of equipment procurement negotiations, developers should ask for information from the equipment suppliers about their supply chains, any forced labor issues and the country where the modules will be manufactured. (For more detail on forced labor concerns, see “Xinjiang: Blocked Solar Panels” in the August 2021 NewsWire.)
Developers should limit risk by negotiating (or re-negotiating) for a termination or refund right for undelivered modules if tariffs exceed a certain threshold, either as a percentage of the purchase price or a certain dollar amount per kilowatt of affected module capacity.
Finally, developers should consider shipping and other importation costs beyond just tariffs, especially as these costs continue to rise and fluctuate.