Business Leasing and Finance News (BLFN) July/August 2009

FOUNDER'S NOTE
By David G. Mayer

                            Ways to Go

For the last few months, I have looked for positive signs, hopeful signs that the economy was bottoming out from the worst recession most of us have ever seen. It has been hard to be optimistic when several of my friends have lost their jobs. About a week ago, I attended a business aviation event and learned that two more of my friends have been “laid off.”

When discussing business with guests they regretfully shared that they could find little new business. Some of the larger participants in the industry held a significant inventory of returned aircraft, and expended their time on numerous workouts and redeployment efforts. That sounded familiar. Most of the work I am handling involves litigation, workouts and opportunistic purchases and sales of distressed assets. Some of my clients look hard for deals that will pass through credit committees, but we all know that, unless a deal is pure “vanilla” with a great credit, the deal won’t even get a decent hearing.

Let’s face it. Limited capital has constrained so many transactions that you have to wonder how much damage the lack of financing may still inflict on the economy. Will unprecedented job losses, rising consumer credit delinquencies, ballooning federal deficit and debt and the volatile stock market shake our fragile confidence or even deepen the recession? Will we experience a jobless recovery? Have we really averted a meltdown of the world’s economic system? These questions remain a huge concern for all of us.

Not to be deterred from my optimism about the future, I searched for positive indicators that the decline will soon be over and the economy will perk up. Amid mostly negative reports I found an article in USA Today titled “What the latest data show: Recession likely to end in Sept.” It said:

The June update of the USA TODAY/IHS Global Insight Economic Outlook Index continues to show signs that the economy will start to recover mildly around October. The decline in real GDP growth accelerated from minus 3.5 percent, at a six-month annualized growth rate, in December 2008 to minus 6 percent in March. It slowed to a more moderate minus 4.3 percent in June, and is expected to reach the break-even point around October-November. Recent gains in the index, though small, have been consistent, which is a good sign.”

Housing starts rose recently in June, the stock market has rocketed upward since mid-July and earnings reports from major banks, though tepid, indicated some slowing of losses and potential for earnings to replace drastic losses. Confidence is building tentatively and slowly, but I will take it. Despite a barrage of criticism about his expanding authority and inflationary monetary policy, Federal Reserve Chairman Bernanke, on July 21, 2009, defended the Fed’s policies that have helped foster economic recovery.

The June forecast of IHS Global Insight and Bernake’s current remarks give me some confidence that the end of the recession will happen this year, but we still have a ways to go. While we should use caution and prudence in our personal and business affairs, we should not do so to the exclusion of evaluating economic data and other information that will help us envision the future and plan for the economic recovery that will almost certainly occur before we know it.

 

1. Fast-Tracked Sales Under Section 363 of the Bankruptcy Code Imperil Lessor Interests

Given the economic conditions prevailing since mid-2008, it is not surprising that we have seen a dramatic increase in the number of bankruptcy filings and new, fast-track methods of assigning substantially all of the debtor’s leases and other executory contracts to a third party.

There is no one event that can be identified as the event that caused the current economic downturn. However, it is generally recognized and backed by scholars like Robert F. Wescott, who gave his testimony before the House Committee on Oversight and Government Reform, that the collapse of Lehman Brothers in September 2008 exacerbated underlying economic difficulties and caused a severe tightening of the credit market.

No End in Sight of Increasing Bankruptcy Cases

In 2008, there were a total of 1,117,771 bankruptcy petitions filed, including 43,546 business filings (i.e., non-personal bankruptcy filings). In contrast, there were a total of 850,912 bankruptcy petitions filed in 2007, of which 28,322 were business filings. Bankruptcy filings are showing no signs of abating this year, where during the first quarter, there were 14,319 business filings. This compares to 8,713 business filings posted in the same quarter last year.

Trend Towards Fast-Track Sales Under Section 363

Along with the substantial increase in the number of bankruptcy filings, there has been a growing trend toward using bankruptcy to sell a company’s best assets on a very fast track (30 to 60 days from case filing is not uncommon), and forcing creditor, contract and lease counterparties to deal with a host of related contract, lease and other rights, on an accelerated basis under Section 363 of the Bankruptcy Code.

Section 363 of the Bankruptcy Code permits a debtor, after notice and hearing, to sell property of the estate other than in the ordinary course of business. In the current economic climate, bankruptcy courts appear to have become especially lenient about permitting Section 363 to be used in lieu of a normal Chapter 11 plan process, bypassing many creditor protections and normal time schedules, and leaving the estate with nothing but cash and less valuable assets to be liquidated. 

The provisions of Section 363 are not new; the ability to sell property outside the ordinary course of business predates the enactment of the Bankruptcy Code in 1978, according to Committee of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1066-69 (2d Cir. 1983). What is new, and what is potentially problematic for non-debtor parties to the debtor’s leases and contracts, is the extremely fast pace of Section 363 sales now permitted at the outset of the case. 

This recent development means that contract and lease counterparties must be especially vigilant in anticipating Chapter 11 filings by their counterparts, and must be prepared to deal immediately after a filing with the rights and leverages they may have in connection with such fast-track sales. 

How Fast-Tracked 363 Proceedings Work

The debtor, at the outset of the case, will file a motion to approve both the sale of substantially all of its assets and a motion to approve bidding procedures for the sale. Debtors often file such motions on the first day of the case, along with the bankruptcy petition itself. In many cases, the debtor will have entered into an asset purchase agreement prepetition with a purchaser who becomes the stalking horse bidder and whose bid becomes the baseline bid.

The bankruptcy court will be asked to approve bidding procedures establishing a due diligence period during which other potential bidders are able to review the assets to be sold and to submit competing bids which exceed in value the baseline bid submitted by the stalking horse bidder. If competing bids are submitted, an actual auction will take place, and the debtor will seek to have the bankruptcy court approve the sale to the successful purchaser. If no competing bids are submitted, the stalking horse bid becomes the successful bid and the bankruptcy court is then asked to approve the sale to the stalking horse.

Frequently, the time between the filing of the bankruptcy petition, the approval of the bidding procedures, the deadline for submitting competing bids and the approval of the sale is extremely short. For instance, in the recent GM Chapter 11 proceeding, the bankruptcy petition was filed on June 1, 2009, the bidding procedures were approved on June 2, the deadline to submit competing bids was June 22 and the hearing to approve the sale to the stalking horse bidder began on June 30, with an order approving the sale issued on July 5.

While GM is an extraordinary case, given the involvement of the U.S. government as both the pre and postpetition lender and the stalking horse bidder and the July 10, 2009 deadline imposed by the U.S. government for approval of the sale, the rapidity of the sale process in the GM case is no longer unique. For example, In re PMTS Liquidation Corp., et al., Case No. 08-11551, U.S. Bankruptcy Court for the District of Delaware, the debtor filed its petition on July 23, 2008; the court approved bidding procedures August 8; it set September 5 as the deadline to submit competing bids; and it held sale hearing on September 9.

SaleProcess Under Section 363 Risks to Lessors and Other Creditors

The expedited 363 sale process poses risks to a non-debtor party, a lessor, lender or other party to whom a debtor has obligations (creditor) under a contract or lease with the debtor. As part of the 363 sale, the debtor will seek to assume unexpired leases and executory contracts and to assign those leases and contracts to the successful purchaser under the provisions of Section 365 of the Bankruptcy Code.

Once an unexpired lease or executory contract is assumed by the debtor and assigned, the creditor must treat the assignee as if it were the original party to the contract. Before an unexpired lease or executory contract can be assumed by the debtor and assigned, the debtor must, under Section 365(b)(1) of the Bankruptcy Code:

• cure, or provide adequate assurance that it will promptly cure, all monetary defaults,
• compensate, or provide adequate assurance that it will promptly compensate the non-debtor party for any actual pecuniary loss resulting from any default and 
• provideadequate assurance of future performance under the lease or contract. 

Therefore, as part of the sale process, debtors will serve notices to non-debtor parties to unexpired leases and executory contracts identifying the leases or contracts to be assumed and assigned, and the amount necessary to cure any monetary defaults. The notice will provide a date certain by which objections to the proposed assumption and assignment of the leases or contracts must be filed, and typically provide that the failure to object will preclude the non-debtor parties from raising any objection to the assumption and assignment of the leases or contracts, including the cure amount.

Crucial Actions for the Creditor to Take When a Section 363 Sale Could Occur

Given that the 363 sale process has the effect of fixing the rights of parties to unexpired leases and executory contracts under an extremely abbreviated schedule, it is crucial that these non-debtor parties take the appropriate action once they learn of a bankruptcy filing involving a 363 sale, and more desirably, even earlier in anticipation of a filing. 

*Warning: As a contact or lease party, do not overlook important legal rights you may have to legally improve your leverage and position heading into a bankruptcy environment. As the non-debtor party, your failure to timely respond to a debtor’s motion to assume and assign a contract or lease will likely preclude you from challenging the assumption and assignment or the cure amount.

• First, monitor bankruptcy filings from the outset, particularly with respect to the debtor’s proposed assumption and assignment of contracts and leases and the associated objection deadlines. It is crucial that either all filings be monitored on the bankruptcy court’s public (pacer) access system or that counsel file a notice of appearance and thereby receive service of all filed documents.

• Second, ensure that the cure amount is correct and has been calculated as of the date of the proposed assumption of the executory contract or unexpired lease.

*Insight Point: Under Section 365, the cure amount must be calculated as of the date of the proposed assumption and not an earlier date (e.g., the date that the sale motion was filed or the date of the assumption notice). The notice of intent to assume and assign often references a cure payment calculated by the debtor as of the date of the notice. Accordingly, as a creditor under the contracts and leases, you must object to the extent that the amount of the cure amount is incorrect or will increase after the notice is served.

• Third, raise promptly any questions or concerns regarding the purchaser’s ability to perform under the lease or contract. It is the debtor’s burden to provide adequate assurance of future performance under the lease or contract and the debtor should be held to that burden.

• Fourth, review the Bankruptcy Code closely to find any of the limited grounds to block the assumption and assignment of certain types of contracts and leases. For instance, Section 365(c)(1) of the Bankruptcy Code provides that a debtor may not “assume or assign” an executory contract or unexpired lease if non-bankruptcy law excuses a non-debtor party from accepting performance from or rendering performance to an entity other than the debtor. 

Conclusion

The current economic climate, in conjunction with the extremely tight credit market, will increase both the number of business bankruptcy cases filed, as well as the number of cases in which all or substantially all of the debtor’s assets are sought to be sold under Section 363 at the outset of the case. In such proceedings, it is crucial that non-debtor parties to the debtor’s contracts and leases closely monitor the bankruptcy case and the debtor’s intended treatment of their contracts and leases, and comply with all objection deadlines. 

Thanks to Michael Richman and Mark Salzberg of the Patton Boggs LLP Bankruptcy and Restructuring Practice Group in New York and Washington, DC, respectively, for contributing this article 

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2. CREZ Initiative Paves the Way for a Wind Energy “Superhighway” in Texas

Texas has already established itself as a leader in the generation of wind energy, but will it burn out? Recognizing the limitations on its growth posed by congestion in its existing transmission grid, Texas has created Competitive Renewable Energy Zones (CREZ).  The central component of CREZ is to add energy transmission capacity. Once completed, this energy “superhighway” should add sufficient capacity to allow Texas to remain a leader in new wind energy generation and transmission well into the future.

ERCOT—“Traffic” Manager for a Crowded Texas Grid

The Electric Reliability Council of Texas, Inc. (ERCOT) is one of the main drivers of wind energy in Texas, meaning it has been one of the drivers of the CREZ initiative as well. ERCOT is an independent system operator (ISO) for approximately 75 percent of the land area in Texas.

*Terms to Know: Federal statutes define an “independent system operator” or “ISO” as an entity approved by the commission to exercise operational or functional control of facilities used for the transmission of electric energy in interstate commerce; and to ensure nondiscriminatory access to the facilities. 16 U.S.C. § 796(28).

ERCOT schedules power on an electric grid that connects 40,000 miles of transmission lines and more than 550 generation units.It operates the electric grid and manages the deregulated market for approximately 22 million Texas customers—representing 85 percent of the state’s total electric load. ERCOT's members include consumers, cooperatives, independent generators, independent power marketers, retail electric providers, investor-owned electric utilities (transmission and distribution providers) and municipal-owned electric utilities. See ERCOT Quick Facts.

ERCOT presently serves a number of capacities under both state and federal law. Under Texas law, ERCOT is responsible for ensuring the reliability and adequacy of the regional electrical grid. Its mission is to “nurture the development of an effective and highly reliable electricity market in Texas.” As it fulfills its mission, ERCOT is fully regulated by the Public Utility Commission of Texas (PUCT), which is responsible for oversight of electric markets operated within the ERCOT region.

ERCOT also answers to the North American Electric Reliability Corporation (NERC), the Federal Energy Regulatory Commission (FERC) and the Texas Regional Entity (Texas RE)—the independent division FERC established pursuant to the Energy Policy Act of 2005 (EPAct) in 2006 to serve as the regional entity (RE) for the ERCOT region.

Because ERCOT is located entirely within the state of Texas, it maintains a unique relationship with FERC. For example, a project outside the boundaries of the ERCOT region would typically be regulated by FERC.  When such a project looks to connect to the ERCOT grid, this will draw FERC into the ERCOT interconnection approval process.

*Tip: To ensure that ERCOT remains free of interstate regulation under FERC, you should seek a determination from FERC disclaiming federal jurisdiction. See PUCT Final Order, § VII.6 (Docket No. 33672); see also Texas House Research Organization (HRO), Interim News 80-7.

The Wind Energy “Rush Hour” in Texas

Texas has long maintained a Renewable Energy Credit (REC) program aimed at shifting the state’s energy portfolio to make better use of its wind and other renewable resources. See ERCOT 2008 Annual Report (May 2009); see also Texas Receives $10B Commitment to Wind Power; Pledges Needed Transmission Lines, BLFN, Issue 59 (Nov. 2006). Under the REC program, retail electricity providers in the state are required to retire nonrenewable capacity in exchange for renewable energy capacity—an amount totaling around 6.7 million RECs each year, with an additional 6.8 million RECs retired voluntarily.

The initial goal the Texas legislature established for the REC program was to install 2,000 MW of additional renewable energy generating capacity by 2009. When Texas reached that goal in 2006, the Texas legislature doubled the goal in 2007, establishing a target of 5,000 MW by 2015 and 10,000 MW by 2025.

By the end of 2008, ERCOT had more than 8,000 MW of installed wind generation, as wind energy showed the largest percentage increase in energy generation—increasing from 2.9 percent of total energy in 2007, to 4.9 percent in 2008. By the end of 2010, installed wind capacity is expected to exceed 9,000 MW, with approximately 50,000 MW of additional wind capacity in various stages of interconnection studies.

The tremendous growth in wind generating capacity and the more general realities of wind energy have combined to give ERCOT a central role in allowing Texas to achieve its goals for increasing wind capacity. Generally, the areas best suited for wind generation tend to be remote areas, requiring transmission to deliver the electricity to consumers, according to the FERC’s 2004 report “Assessing the State of Wind Energy.” Moreover, the comparably short period for developing and constructing a wind farm project (against the longer process for transmission projects) will often leave wind farm projects “waiting for transmission expansion to catch up.”

As a result, the rush of wind generation capacity has “outpaced” the capacity of the transmission system, which can accommodate a maximum of 4,500 MW of wind energy. See ERCOT 2008 Annual Report; see also Texas Wind Energy Tops Market as Transmission Capacity Falls Short, BLFN, Issue 76 (Apr. 2008). In other words, wind energy is stranded by the lack of transmission lines from West Texas (an active area of wind energy development that is already significantly congested) to the load centers such as Dallas and Houston.

Like building a new interstate highway, adding bulk transmission capacity to address this shortfall can be problematic due to the distance and costs of installing transmission lines. Following a mandate from the Texas legislature, however, the PUCT and ERCOT have given the green light to make a $5 billion investment that should translate Texas’ goals of increased transmission capacity into a reality.

CREZ: A Green-Light for Wind Energy Development

In anticipation of the challenges of delivering wind energy to the electricity market and urban load centers, the Texas legislature passed Senate Bill No. 20 (S.B. 20) in 2005. See also As Wind Energy Makes Gains, Texas Blows Past Competition, BLFN, Issue 69 (Sept. 2007).This legislation established a process for the PUCT to preapprove CREZs—zones for the development of transmission capacity for wind energy and other renewable energy projects.

The conventional transmission planning mechanism employed by the PUCT prior to CREZ had largely failed to address the realities of wind energy. See CREZ in Texas (NREL 2009). The process had resulted in a “circular dilemma” — no new wind projects could be constructed without a commitment that transmission would exist and no new transmission would be constructed without commitments that wind projects would exist. The CREZ initiative created a statutory presumption of need, giving the PUCT the authority to approve transmission based upon the “informed expectation” of future renewable development.

The CREZ initiative should eliminate bottlenecks (both procedural and tangible) to accessing wind energy resources in those areas of the state where future development is expected to occur. After ERCOT completed studies of 25 wind development areas in late 2006, the PUCT, in October 2007, issued interim CREZ zone designations for five areas in the Texas Panhandle and in West Texas. The designations contemplated optimal transmission lines and financial commitments of developers to the CREZ goals for developing transmission infrastructure.

In July 2007, the PUCT issued an interim final order outlining four scenarios for different levels of wind development in the CREZs ranging from 12,000 MW to 24,000 MW, depending on cost and the number of wind farms. In April 2008, ERCOT submitted its CREZ Transmission Optimization Study (CTO Study) to the PUCT, which evaluated a variety of transmission solutions under the four scenarios.

In July 2008, the PUCT (Docket No. 33672) selected CREZ Scenario 2. See Interim News 80-7. The plans included under CREZ Scenario 2 provide for more than 18,000 MW of added wind capacity, providing transmission capacity to link all five of the zones identified by the PUCT as part of the CREZ initiative. See CTO Study. 

Texas Moves from Blueprints to Backhoes

After finalizing plans for the route which the CREZ “superhighway” would take, the PUCT quickly moved forward with plans to begin construction on the new route. In March 2009, the PUCT issued a final order (Docket No. 35665) assigning the nearly $5 billion of transmission projects slated for development under CREZ Scenario 2.

Through this order, the PUCT directed more than a dozen transmission service providers (TSPs) to implement the projects that will upgrade hundreds of miles of existing lines and create more than 2,000 miles of new transmission lines. Of the designated TSPs, the largest commitments include those undertaken by:

• Oncor ($1.34 billion);
• Electric Transmission Texas LLC ($789 million);
• LCRA Transmission Services Corp. ($750 million);
• Lone Star Transmission LLC ($564 million);
• Wind Energy Transmission Texas LLC ($402 million);
• Sharyland Utilities ($394 million); and
• Cross Texas Transmission LLC ($390 million).

Currently, it is anticipated that the build-out for the expanded transmission capacity will take between three to five years, with a final deadline of 2013 for completing all CREZ-related projects. See Interim News 80-7. 

*Opportunity Point: The narrow timeframe for implementation, and the billions of dollars in promised investments means now may be the perfect opportunity for you to get involved in wind energy development or predevelopment. To follow future news and developments related to the CREZ initiative, you can sign up for the Competitive Renewable Energy Zone Transmission Service Providers listserv at http://lists.ercot.com.

Tollway vs. Freeway: Consumers Invest in CREZ Development

The plan for building the needed transmission facilities to ease congestion and carry power from wind farms to the load centers has taken years to formulate. See Texas Receives $10B Commitment to Wind Power; Pledges Needed Transmission Lines, BLFN, Issue 59 (Nov. 2006). The CREZ initiative demonstrates that Texas has taken significant (but slow) action on this aspect of developing renewable energy transmission and generation.

As the $5 billion price tag suggests, developing the infrastructure under the CREZ initiative is costly. Generally, the Texas legislature has established (through S.B. 7) that ERCOT will apply a single method for allocating the costs of transmission infrastructure—the “postage stamp” pricing mechanism. See CREZ in Texas.

*Technical Point: Under this mechanism, the transmission rate for a transmission-owning utility is based on the ERCOT utilities' combined annual costs of transmission divided by the total demand placed on the combined transmission systems of all transmission-owning utilities within ERCOT.

In short, the state of Texas employs a cost allocation methodology which broadly allocates the costs of the transmission improvements to consumers across the ERCOT grid instead of specific generator developers. As the expanded transmission capacity develops through CREZ, the PUCT anticipates that the improvements could result in a 4 to 7 percent increase in residential electricity bills. See Texas HRO, Capturing the Wind. This will likely translate to an average increase of about $4 per month, per customer. See Interim News 80-7.

Wind Energy Development Shifts into Overdrive

The March 2009 final order from the PUCT does not represent the end of the development process for Texas. History shows that the regulatory and technical aspects of building transmission lines are extremely complex and time consuming. Industry players can expect further analysis, planning and investment by stakeholders and policymakers to achieve the ultimate goal of providing capacity to transmit energy from renewable resources. Nevertheless, Texas has taken important steps to meet these challenges.

*Insight Point: Beyond the planning and regulatory efforts undertaken by the State of Texas, the federal government will likely be active in issues of electricity transmission as well. Stakeholders, investors and policymakers should look to make use of federal tax incentives and new funding initiatives, such as the $4 billion the Obama administration is making available for smart grid technology development initiatives. See Press Release, Biden Outlines Funding for Smart Grid (April 2009); see also Stimulus Cash Grants Hold Promise to Energize Wind Power Industry, BLFN (Mar.-Apr. 2009).

Wind energy generation will continue to increase in the coming years. To accommodate this growth, the PUCT, ERCOT and the Texas legislature must build on the progress of the CREZ initiative to create the stable regulatory framework required to encourage the development of transmission lines to carry the power from wind-rich areas of rural West Texas to the state’s urban areas to the east. Given the recent progress of the state’s CREZ initiative, the future for investment in transmission facilities in Texas appears bright.

Ultimately, the state’s policymakers must continue to support the economic case for investing in wind energy. By offering a fertile ground for investment and development, the state can ensure that the current bumper crop of wind farms sprouting up throughout the state doesn’t wither in the hot Texas sun.

Thanks to James Voelker of Patton Boggs’ Dallas office for contributing this article.

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3. Leasing Renewable Energy Projects Gets Boost From Treasury Guidance on Cash Grants

Renewable energy projects may get a new lease on life now that the Department of the Treasury (Treasury) has just issued its highly-anticipated guidance (Guidance) on how to apply for and keep cash grants in lieu of energy investment tax credits.

The 20-page Guidance offers favorable ways to use leasing to obtain, use and transfer the rights to cash grants. The purpose of the cash grants is to reimburse eligible applicants for a portion of the expense of property that qualifies for the grant, according to the July release of Payments for Specified Energy Property in Lieu of Tax Credits under the American Recovery and Reinvestment Act of 2009 – Program Guidance.

*Action Point: The Guidance includes a six-page application form and a terms and conditions document, which is essentially a contract between the party seeking the grant and Treasury. If you intend to apply for a grant, you should get to work on the application and submit on or as soon as you can after August 1, 2009 – the first date Treasury will accept your application.

However, before you rush your application, keep in mind that the Guidance states that applications must be submitted after the property has been placed in service and before October 1, 2011, or, if the property is to be placed in service after September 30, 2011, by October 1, 2011.

*Technical Point: The applicant must have a DUNS number from Dun & Bradstreet and must register with the Central Contractor Registration (CCR).

Eligible Property

The Guidance covers applications for grants, eligibility of property, eligibility of claimants for the cash grants and recapturing of grants. It also acknowledges that a lessor of eligible property (referred to as “specified energy property”) may obtain a grant and that, in certain cases, the lessor can transfer to the lessee the right to obtain the grant.

The American Recovery and Reinvestment Act of 2009 (ARRA) permits taxpayers to receive a grant from Treasury in lieu of claiming certain energy investment tax credits (including investments tax credits (ETC) that ARRA permits to be claimed in lieu of production tax credits (PTC)) for renewable and alternative energy property. The grants generally equal the amount of the credit that the taxpayer could have claimed if the taxpayer had the ability to fully utilize the credit. For example, “large wind” and “solar” projects can each receive a 30 percent credit of their eligible cost basis.

Grants are available for property placed in service in 2009 or 2010. They are also available where construction begins in 2009 or 2010 if the property is placed in service before the credit termination date for the property such as 2012 for wind and 2016 for solar.

*Technical Point: Qualified property includes only tangible property that is both used as an integral part of the activity performed by the qualified facility and located at the site of the qualified facility. Qualified property does not include a building, but it may include structural components of a building. Only costs that are capitalized can be taken into account in determining the amount of the grant. If the owner claims a Section 179 expensing deduction for part of the cost of a facility, that portion of the cost is not taken into account in determining the amount of the grant.

Grants With Respect to Leased Property

The Guidance specifically recognizes that grants may be issued with respect to leased property. The owner/lessor of the leased property may claim the credit. Alternatively, the owner of the leased property may make an irrevocable election to let the lessee claim the grant. The election would be made by written agreement between the lessee and lessor and would generally follow the rules of the Internal Revenue Code (IRC) applicable to a lessor passing a credit through to the lessee. The lessee must agree to include ratably in gross income over 60 months an amount equal to 50 percent of the grant. This inclusion in gross income corresponds to the basis reduction that owner must take by reason of claiming a grant or energy investment tax credit.

*Tip: The applicant will be required to provide Treasury with a copy of the signed agreement, so it may be best to include the agreement in a document separate from the lease.

As a general rule, a grant may be claimed only by the original user of the property. However, a special sale-leaseback rule enables the owner-lessor to seek the grant if the lessee places the property in service and sells and leases it back within three months of the original placed-in-service date. The Guidance prohibits mutual savings banks and other similar financial organizations, regulated investment funds and REITs from passing the right to claim the grant to lessees.

*Insight Point: Sale – lease backs, as with other leases, enable a project to finance 100 percent of the cost of eligible property. If the cash grant can be used to reduce the cost of the project, leasing may become an attractive alternative to debt financing and overcome some resistance in the market to the supposed complexity of leasing. Leasing of facilities is neither science nor art. It is a well-tested financing device that can expand the limited available capital for renewable energy projects. In the final analysis, however, leasing will only make sense when the numbers justify it as the best way to raise and deploy capital.

Recapture Rules

The Guidance indicates that grants are subject to recapture (i.e., an obligation to repay all or a portion of the grant to Treasury) if the property is sold to a “disqualified person” or the property ceases to qualify as property that would have been eligible for a grant (e.g., because the property is being used for a different purpose). Twenty percent of the grant vests on each anniversary of the placed-in-service date, so that a transfer to a disqualified person after the fifth anniversary of the placed-in-service date will not result in recapture.

The term “disqualified person” is a person who is not eligible to receive cash grants, including:

• any federal, state or local government, including any political subdivision, agency or instrumentality thereof,

• any organization that is described in section 501(c) of the IRC and is exempt from tax under section 501(a) of the IRC,

• “qualified issuers" under IRC section 54(j)(4)),

• any partnership or other pass-thru entity, any direct or indirect partner (or other holder of an equity or profits interest) of which is an organization or entity described above unless this person only owns an indirect interest in the applicant through a taxable C corporation.

*Warning: REITs and electric cooperatives are not pass-through entities.

The Guidance indicates that a sale of property to a person who is not disqualified avoids recapture if the property continues to be qualified and the purchaser agrees to be jointly liable with the seller for recapture.

Under the Guidance, if a lessor transfers to the lessee a right to apply for the grant and the lessee receives the grant, the lessee will be liable for the recapture amount if the lessor subsequently sells the property to a disqualified person.

*Warning:  Even if an applicant no longer controls a project, the applicant will remain liable to Treasury.

If a grant has been claimed with respect to property under a lease and possession of the property changes before the grant is fully vested, the grant will be subject to recapture if the use of the property changes so that the property would no longer be qualified property. In that case, the party claiming the credit would be liable for the recapture. The change in possession of the property can either be by reason of termination of the lease or the lessee’s transfer of its rights under the lease.

*Insight Point:  When you negotiate your lease agreement, you should consider including the same types of covenants and indemnities that you would include in the leases of the property eligible for an ETC. For you leasing pros that remember the use of investment tax credit (ITC) in the past, you would take the same approach as when the investment tax credit was a general ITC for equipment leasing.

The obligation to repay a grant in the case of an event leading to recapture is unsecured. Treasury will not be taking security interests in property to secure the potential repayment obligation.

Assignment of Grants

Applicants for grants may assign the grant payments to third parties by providing a Notice of Assignment and complying with the Federal Assignment of Claims Act (31 U.S.C. 3727).

For a relatively short period of time, Treasury will give renewable energy projects a tax benefit in the form of a tax credit in lieu of the alphabet sound of investment incentives: PTC, ETC or even the ITC. Although the Guidance may seem complex, the aim is simple: To give renewable energy a chance to revive and grow in these tough economic times. Even this temporary incentive from Treasury will rapidly gain wide acceptance and significant use in today’s renewable energy markets.

Thanks to George Schutzer of the Patton Boggs LLP Tax Practice Group in Washington, DC for editing this article.

 

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4. BLFN’s Finance 101: What Is a “Breach of Contract”?

Have you been sued in a commercial transaction? Have you sued someone else because you thought the other party (breaching party) failed to perform its obligations to you (non-breaching party) under your contract? 

In the current economic downturn, lawsuits have proliferated due to claims that one party or the other party had breached a contract. For example, if a borrower agrees to maintain bank balances at Bank X, but closes the account and moves the money to an unknown location, the counterparty (lender) can assert that the borrower breached its contract with the lender. 

To make a valid claim for a breach of contract, one party, such as the lender, must establish under applicable law (1) the existence of a contract with the borrower, (2) due performance of the contract by the lender, (3) breach of the contract by the borrower and (4) damages incurred by the lender resulting from the breach. Century Maxim Const. Corp. v. One Bryant Park, LLC, 2009 WL 1218895, at *13 (N.Y. Sup. 2009); Coastal Aviation, Inc. v. Commander Aircraft Co., 937 F. Supp. 1051, 1060 (S.D.N.Y. 1996), aff’d 108 F.3d 1369 (2d Cir. 1997). 

If the lender refuses to make loan advances to the borrower when the borrower fully complies with all of its obligations under the loan documents, the borrower could (and perhaps should) argue that the lender did not satisfy requirement (2) above, and thus has no breach of contract claim.

The next time a situation arises where one party, such as a borrower, fails to meet its obligations to the other party, such as a lender, the other party (lender) should explore whether a breach of contract has occurred.  

*Tip: Today when bankruptcies and liquidations have become commonplace, if you are the party alleging a breach of contract by the other party, you should act as quickly as possible to assess the breach and then exercise your rights and remedies. You can address little issues, but you should recognize and be anticipating any material breach of contract to seek meaningful relief in the courts.

 

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About Patton Boggs LLP; NEW: PB Capital Resource Center; Publications and Radio Interview: NBAA’s Bolen & Mayer Podcast on Business Aviation – July 30

About Patton Boggs

Patton Boggs LLP is a law firm of approximately 600 attorneys and other professionals located in Washington DC, Northern Virginia, New Jersey, New York, Dallas, Denver, Anchorage and internationally in Abu Dhabi, United Arab Emirates and Doha, Qatar.

Patton Boggs has major practice areas in business, intellectual property, public policy and Litigation. These areas are composed of many practice groups designed specifically to meet client needs and the trends in developing legal markets. David G. Mayer often focuses on capital equipment and facility financing and development in energy, transportation, infrastructure, aviation and technology transactions, workouts and litigation.

The firm provides a broad array of skills in domestic and international business transactions, including equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, aviation and transactions law, federal leasing, project finance, real estate, health care, pharmaceuticals, technology transactions and public policy work.

The equipment finance practice at Patton Boggs regularly involves the buying, selling, financing and leasing of personal property of all kinds, including business aircraft, energy facilities, power plants (including wind farms and other renewable energy facilities) and technology and health care assets.

When these transactions encounter defaults or other disputes, Patton Boggs responds with a team of business transaction lawyers, who have extensive restructuring and workout experience, litigators, who manage court actions and alternative dispute resolution proceeding, and bankruptcy lawyers, who assist in restructuring transactions, handle workouts, advise on potential bankruptcy filings and litigate and otherwise participate in the entire bankruptcy process.

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New: PB CAPITAL RESOURCE CENTER

• Capital Markets Web site– PB Capital Markets is the firm’s dedicatedWeb site offering current political news and in-depth analysis of the most important legislation pertaining to the crisis in the financial services and banking industries today. Click on Capital Markets.
• Capital Thinking Magazine – For insightful interviews with business and political leaders and more in-depth information on business, finance, politics and the law, pick up a copy of Patton Boggs’ Capital Thinking magazine. Published quarterly, Capital Thinking features articles from top business and legal minds providing readers with actionable tips on timely topics.
• Capital Thinking Podcasts and Internet Radio Show – PB Partner Kevin O’Neill hosts both a weekly podcast series and a weekly Internet radio show that delivers the latest news and insight into policy, law and politics in Washington. The PB podcast series is updated every Monday and is available on the firm’s Web site and iTunes. Capital Thinking, Patton Boggs’ weekly Internet radio show, airs live every Thursday at 12:00 Noon ET and 9:00 a.m. PT on VoiceAmerica Business network. Top guests, including politicians, business leaders, public policy advisors and PB partners, join Kevin to discuss how legislation and business developments raise a wide array of pressing issues in the United States.
• Patton Boggs Social Media - Follow Patton Boggs' recent coverage on Facebook and Twitter.

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PUBLIC POLICY MEMORANDA

• Patton Boggs Assessment: Beyond President Obama's Busy First 100 Days
  June 8, 2009
  
  
• NO SMALL CHANGE:  The Stimulus Package and its Impact
  Updated: July 2009 
  
  Click here to download the general overview [PDF]
  
  In its final form, the American Economic Recovery and Reinvestment Act of 2009 (H.R. 1) bill passed February 13 is the largest combined spending and tax bill in American history, with a total of $789.5 billion in spending and tax cuts. The bill will impact a wide range of businesses and industries from health care to energy, to education and transportation.
  
  To provide a sense of the package's overall funding levels, Patton Boggs has prepared a general overview of the bill by subject area (please note we are not reporting on every aspect of the bill).
  
  
• Capital Thinking Internet Radio (Patton Boggs podcast), with host Kevin O’Neill: Interview of Ed Bolen, president and CEO of the National Business Aviation Association and David G. Mayer, Patton Boggs partner, July 30, 2009 (date other date to be announced), regarding the significant challenges and trends in business aviation (BA) today. Ed and David plan to address the current economic condition of the BA market, the public perception challenges for BA and the reality of dealing with distressed transactions in an unstable market.

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Partial List of Publications and Radio Interview

The following is a partial list of articles written or co-authored by David G. Mayer and a mention of a radio show appearance by David G. Mayer:

• Capital Thinking Internet Radio (Patton Boggs Podcast), with host Kevin O’Neill: Interview of David G. Mayer on March 12, 2009 regarding trends in financing and development of natural gas storage facilities. To listen to the interview, click on Mayer Interview.
• U.S. Court of Appeals Upholds Graves Amendment in Garcia v. Vanguard, by Connie Ariagno and David G. Mayer, with the assistance of Tyson Wanjura, LNJ Leasing Newsletter (Dec. 2008).
• Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Dec. 2007).
• Navigating the New Reality of Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Nov. 2007).
• Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).

 

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Thanks to BLFN’s Team

I would like to thank BLFN’s team at Patton Boggs LLP. The team includes Tyson Wanjura, an associate in Dallas and the Patton Boggs staff: our marketing writers Jennifer Becker and Jackie Gilbert, our marketing manager Mark Holub, our project manager Melissa Green, Penny Utley, our subscription coordinator and our designer Winston Jackson. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and Web site reviewer for BLFN, and our Chief Marketing Officer Mary Kimber, for assisting BLFN through our firm’s editing, design and posting process.

All the best,

David

David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 phone)
(214) 758-1550 (fax)
E-Mail: dmayer@pattonboggs.com

© David G. Mayer 2009

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