Business Leasing and Finance News (BLFN) September/October 2009
By David G. Mayer
It’s hard to get a good idea down. In the past month or so, I have seen clients find and exploit a niche in the marketplace with potential to lift their revenues and their spirits. One bank found a certain underserved transportation equipment segment where it could provide profitable and relatively safe financing. Few other financiers occupied the space. Another client found an opportunistic way to buy distressed assets and “flip” them at an attractive spread. Most other buyers could not structure the transaction to mitigate the risk.
Our client’s ingenuity, I suspect, represents a trend you may have seen or implemented. In the absence of growth in traditional areas of your business due to the recession or other economic pressures, many of us have had to look hard to fill gaps in specialized markets, products and services to profit or survive while we try to maintain our core businesses.
These clients shared a common theme. They played to their strengths, understood their business objectives cold, developed a relatively simple business plan and executed the plan vigorously. The results remain to be seen, but the business ideas seem clear, if not obvious – something like the pop-top can that everyone thought was so simple after the inventors revealed their secret. Although the businesses may differ, our client’s efforts speak to a broad audience that can follow their example. They demonstrate how to take risks prudently and thoughtfully with other people’s money.
When I was internal counsel at a well-known finance company many years ago, I had the privilege of sitting on the finance committee from time to time. At these meetings we would be asked to approve or decline deals presented in a “write-up.” I read the package and prepared to vote, but the rubber really hit the road when the chairman asked each of us on the committee, one at a time, to confirm that we would vote “yes” if we had to invest our own cash in the deal. That certainly got my attention and made me focus on what my vote meant to the stakeholders, and to me.
So too should each of us focus on how we will seize upon underserved, niche or growing markets where we can or must do business, as if each investment were being made with our own money. For most of us, these investments are not an exercise, but our reality. Perhaps, despite the lousy economy, we will succeed in filling gaps in our world and find satisfaction in investing and making money in the process.
Thanks for reading this issue of BLFN. We hope you will find the articles of value and interest to your business.
1. Is Leasing a Viable Method to Finance Wind Energy Projects?
Wind energy is a dynamic and growing business with needs for massive amounts of capital — capital that is either sitting on the sidelines or is unavailable to most projects today. Equipment financiers, including lessors, have not been recognized as a source of capital for wind energy projects, but have invested in energy equipment and facilities for decades.
Equipment finance, including leasing, provides more than $600 billion per year domestically of investment in equipment, facilities and other capital assets. According to the Equipment Leasing and Finance Association: “about 80 percent of … businesses in the United States use equipment finance to fund their operations … A single transaction may involve buying, selling (including conditional sales) and financing plant and equipment [including energy facilities] … [E]quipment finance is … one of the most important ways for businesses to invest in capital while managing their balance sheets and cash flow.”
With all its positive attributes and potential, will equipment finance gain acceptance in the wind energy marketplace as a source of capital to finance wind farms or will developers, lenders and borrowers blow it off as technically feasible but an economically futile method of financing entire wind farms projects? If equipment financiers, including lessors, cannot or will not finance an entire wind farm, can they still invest in equipment and facilities related to and part of an entire facility?
Trend in Wind Energy Growth
For those participants in wind energy development and financing, 2009 has been anything but a banner year. Compared to 2008, the deal flow has fallen dramatically and financing sources have all but disappeared with the exception of approximately 20 Japanese, European and Asian banks. No one is surprised today that the financing game has been fundamentally altered by the global economic crisis, bank losses and the recession. The unanswered question is how and from what sources will wind energy projects obtain financing to continue their growth.
Even though business in the wind industry slowed significantly in 2009, wind energy now accounts for about 1 percent of global electricity produced, and is expected to increase to 700 GW in 2017 (6 percent of global electricity produced). The Department of Energy (DOE) reports that wind energy installations accounted for 42 percent of the net energy capacity added in the United States in 2008, with 8,558 MW installed and $16 billion invested. See 2008 Wind Technologies Market Report, DOE (2008).
The United States out produces the rest of the world in wind energy generation. See U.S. becomes top wind producer, solar next, Reuters (Feb. 2, 2009). The American Wind Energy Association (AWEA) confirms that the top five states by total installed capacity of wind energy are Texas, Iowa, California, Minnesota and Washington, ranging from 7,118MW (TX) to 1,447MW (WA). These states and others will almost certainly continue to develop and put in service additional wind energy capacity as the economy improves and financing sources reappear. Lenders and facility/equipment financiers alike should have ample opportunity to finance projects as our energy future unfolds.
The Competition: Utilities at Work
While lenders and lessors may duel for opportunities to finance wind energy projects, utilities have made a strong foray into the various markets and have gobbled up opportunities to develop and operate projects that lenders and lessors cannot match. Unlike most private developers, utilities can use their balance sheets (cash) to fund or acquire wind projects, making them formidable competition for developers, lenders and lessors.
Utilities have several goals to achieve in the wind energy business. They recognize the need to produce or acquire green energy for their environmental and public relations purposes. They also need to meet requirements under renewable portfolio standards (RPS) in their respective states. At this point, 24 states and the District of Columbia have enacted RPS standards. Five other states, North Dakota, South Dakota, Utah, Virginia and Vermont, have nonbinding goals for adoption of renewable energy instead of an RPS. The federal government is considering a national renewable energy standard. Florida appears to be considering a draft of a renewal portfolio standard.
*Term to Know: A “renewable portfolio standard” is a state policy that requires electricity providers to obtain a minimum percentage of their power from renewable energy resources by a certain date. For the text version of states with an RPS, see the following links: Arizona, California, Colorado, Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Iowa, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, Rhode Island, South Dakota, Texas, Utah, Vermont, Virginia, Washington and Wisconsin. See Map Linking to Descriptions of State Renewable Portfolio Standards.
Utilities have expanded their efforts in and share of the wind energy market and public policy incentives such as a state RPS and federal RES (renewable energy standards) will only spur them on into leading, if not a controlling, part of the wind energy business.
Perhaps the most important point for lenders and lessors is that utilities must frequently buy power from the developers to hit their RPS requirements. This policy-driven reality powers up financing and leasing of wind energy projects in the United States.
Filling the Gaps: A Lessor Opportunity
The financing of wind energy businesses may have stalled or slowed this year, but project development and financing opportunities that lenders will seldom consider still seem to be cropping up. As the economy warms up, equipment/facility financiers should step up and gain some footing in financing wind farms. Lessors can directly compete with lenders where a lack of capital constrains their ability to fund good projects. In addition, using tax benefits under leases structured for the lessee’s needs, lessors may be able to provide a viable alternative for financing wind projects in the form of lower and well-structured rent payments.
*Techincal Point: Article 2A, Section 103(j) defines a lease in part as follows: “‘lease’ means a transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease… .”
The federal tax incentive to finance capital assets - ITC - that propelled leveraged leasing to the top of its game in the 1970s has reappeared under the American Recovery and Reinvestment Act (ARRA) with significant enhancements. Equipment financiers may, for the first time in nearly four decades, be in a position to reinvigorate traditional lease financing that they enjoyed when they could monetize the ITC. The act expands one of the components of the ITC – the energy credit.
*Warning: Due to a pending joint lease accounting project of the International Accounting Standards Board and the Financial Accounting Standards Board, the leveraged lease accounting treatment currently available under the Statement of Financial Accounting No. 13 (FAS No. 13) will likely not survive. Accordingly, sponsors should evaluate the accounting implications of using a leveraged lease structure before committing to do so. The lease accounting project is targeted for completion in 2011, with implementation timing and details to be determined.
Under ARRA, the wind farms must constitute “facilities” that generate electricity from renewable energy sources, such as wind power to be eligible for the ITC. Both the availability of the ITC and the Cash Grant in lieu of the ITC may enable lessors to fund projects and be competitive with lenders. However, at this point equipment financiers have not yet reached for the brass ring, if one exists for them.
*Term to Know: The term "facility" under section 45(d)(1) of the Internal Revenue Code of 1986, as amended, means each separate wind turbine, together with the tower on which the turbine is mounted and the supporting pad on which the tower is situated. See Rev. Rul. 94-31, 1994-1 C.B. 16 (May 23, 1994), with respect to electricity produced from wind energy.
As the economy begins its slow recovery, wind project financing may enable lessors to bring tax advantaged capital into the renewable energy market that is starved for more capital to grow as it did in 2007 – 2008 (record years for the industry). But, for the remainder of 2009, lenders and lessors may face a similar challenge of finding projects that have advanced far enough to merit loan or lease financing.
Weighing Factors For and Against Leasing/Equipment Finance
Developers and financiers have been evaluating the feasibility of leasing as an alternative to lending for a project financing. The analysis includes numerous positive and negative factors pertaining to leasing or other equipment financing. The positive factors of leasing wind farms include the following:
For Leasing/Equipment Finance:
- New Capital: Equipment financiers may provide a new source of capital. Even if the equipment financier cannot finance an entire facility, it may be able to finance equipment used in or related to the facility to reduce the funding amount required from nonrecourse lenders.
*Insight Point: The same financier, typically a bank, which provides a nonrecourse loan to a project may also have an equipment leasing/equipment finance division that may wish to participate in a financing. However, on an institutional level, the leasing/equipment finance division may not have any additional credit capacity with respect to the same project or developer than its project finance group. Further, the leasing/equipment finance group may have little or no relevant experience in financing wind energy projects. Finally, leasing and equipment finance may be treated as an alternative financing product that lenders offer together with or in place of loans if the developer wishes to weigh his options between a lease and a loan structure. As a result, it is not entirely clear whether leasing, in fact, will provide new capital or an alternative type of financing provided by the same financial institution. If an equipment finance company separately has capacity to provide a loan to or lease a facility, that company may increase available capital for wind farms.
- 100 Percent Financing: Lessors can provide 100 percent financing in a lease financing of a wind farm or leased equipment for a developer/project company as lessee. This capital structure enables the lessee to deploy equity in other parts of the facility instead of financing every item of property in the project with loans.
- Flexible Term: The term of a lease can optimize the after-tax economics and cash flow of the lessor and the lessee. Rent may, within certain tax restraints, be structured to match expected cash flows to free up cash to pay lenders, operations and maintenance costs and fill reserves.
- Use of Tax Benefits: Lessors with a “tax appetite” can use accelerated depreciation and the ITC or Cash Grant (in lieu of the ITC) in the most tax-efficient manner and structure for the lessee.
- Sale-Leasebacks: Lessors can purchase a project in a sale-leaseback transaction at a price that is potentially greater than the actual installed cost, to the extent appraisal supports the fair-market value (FMV) price of the project. The premium, if any, of such FMV in excess of the installed cost may provide cash for the developer that may reduce the need for a portion of anticipated project loans. In addition, the lessor can, within a certain time period (three months) and following certain procedures, transfer the ITC or Cash Grants through to the lessee to achieve the most useful tax structure.
- Single Investor or Leveraged Leases: A developer can elect to finance its project with a single investor lease, which involves a financing by one or more lessors using equity funds only as it relates to the lessee. Alternatively, a lessor can offer a leveraged lease financing, which uses a loan to the lessor (60 to 80 percent of project cost), secured by the facility assets, to provide 100 percent financing of a project. The developer provides the remaining 20 to 40 percent of the cost.
*Tip: Despite the adverse direction of lease accounting (discussed below), you should consider a single investor lease as the best option for accounting reasons. However, you should still evaluate a leveraged lease for your project because it has positive attributes even without off-balance sheet accounting (for lessees) and accelerated income in the early years of the lease (for lessors).
- Nonrecourse: A facility lease or other financing may be nonrecourse to the sponsor/developer just like a nonrecourse loan.
- Lower Payments (Rents): A developer/lessee can benefit from the pricing (lower rents) in a lease transaction. The lower rents derive in part from the residual value (RV) risk taken by the lessor and longer term of the lease than a loan.
*Tip: As a lessor, look for opportunities involving long-term power-purchase agreements (PPAs) of at least 15 to 20 years in duration. These long-term PPAs may enable you to structure acceptable economics consistent with managing your RV risk and tax requirements. You should obtain tax advice on any structure you select, taking into account the tax guidelines and related judicial precedent.
PPAs do exist for long terms. For example, CPV Renewable Energy Company (CPV REC) executed a 20-year power-purchase agreement with Oklahoma Gas and Electric Company for its 152 MW Keenan II wind energy project in Woodward County, Oklahoma. See CPV Renewable Energy Company Announces Long-Term PPA with OG&E for Wind Energy in Oklahoma, PR Newswire (Sept. 29, 2009). Similarly, Detroit Edison entered into a 20-year PPA with Michigan-based Heritage Sustainable Energy on May 15, 2009 to purchase wind power and renewable energy credits. Horizon Wind scored a 15-year PPA last summer with AmerenUE, in which Horizon agreed to sell wind energy to AmerenUE from the 102.3 MW second phase of its 300MW Pioneer Prairie Wind Farm. See Energy from Pioneer Prairie Wind Farm to Power Missouri Homes, Reuters (June 18, 2009). Structured properly, this type of long-term PPA should alleviate most of the concerns about RV risk.
- Construction and Long-Term Financing: Lessors can provide both construction financing and long-term lease financing just like lenders.
- Equipment/Facility Financing: Equipment financiers have flexibility to lease equipment used in or related to the wind power facility. For example, lessors can lease ancillary equipment, construction vehicles, spare wind turbines, transmission equipment and other assets used in the operation of the facility and which can be distinguished from collateral security for a lender.
*Tip: As a lessor or lender, if you elect to enter into an equipment leasing transaction, you will probably need an intercreditor agreement with the lenders. This type of intercreditor agreement is unique because you do not establish rules for priority, subordination and default rights. You also structure the intercreditor arrangement to reflect the relationship between a senior lender and an owner (lessor) of equipment (not another lender). If a transaction is not a lease, but a disguised financing, the intercreditor agreement will probably contain more typical multilender provisions.
Against Leasing/Equipment Finance:
Although leasing may only appeal to a limited segment of the market for wind energy financing, the reality is that, even weighing all the positive attributes of leasing, lenders and developers in the market currently seem resistant to using leasing as a tool to finance entire wind farm projects. Some of the negative factors they may cite and other negative factors include the following:
- Equity: Little or any true lease tax equity players appear to be active in market currently for use in leveraged leases or back-leveraged leases. The equity must be eligible to use the ITC or the Cash Grant (in lieu of the ITC). The lease products would probably be uncompetitive without the tax benefits.
- Term: A typical lease or leveraged lease term is likely to be much longer than a typical 8-10 year nonrecourse loan. A lease term could be 15-20 years (but varies by lessor and transaction). That term (or close to it) is a long period of time for wind energy assets to perform efficiently (even with annual degradations assumed or maintain anticipated cash flows and other economic assumptions) or to rely on economic assumptions without substantial supporting experience in real deals.
- Residual Value: RV assumptions and risk pose one of the most difficult challenges for lessors who must assume and retain RV risk under the tax guidelines. See Rev. Proc. 2001-28 2001-19 I.R.B. at page 115607. Lessors may have difficulty predicting or relying on RVS of the wind turbines or other property in a project after the lease term for lack of history on the particular asset type. However, a lessor should be able to obtain a reliable appraisal that wind assets will have a 25 year useful life to support tax assumptions.
*Technical Point: The IRS developed this revenue procedure to provide guidelines for advance ruling purposes in determining whether certain transactions purporting to be leases of property are, in fact, leases for federal income tax purposes. See Section 1, Purpose, Rev. Proc. 2001-28 at page 1156-7.
- Tax: A lessee’s interests are served by having a fixed price purchase option or early termination option, but the IRS is apparently hounding investors only to use fair-market value leases, which makes the risk of the RV very significant (20 percent or more) and chilling on doing leveraged leases;
- Complexity: Some lenders and developers perceive that lease structures may be too complex and may require more structuring, negotiating, time and cost to close when compared to a nonrecourse loan.
- Credit Restraints: Lessors face a challenging process to obtain credit approvals very similar to that of nonrecourse project lenders.
- Partnership Flip Structure Versus a Lease: The “partnership flip” structure refers to a tax partnership arrangement between a project company (owner, developer and manager of a facility) and its investor(s) that allows the investor(s) to receive the agreed after-tax internal rate of return derived from the production tax credit (PTC) over a period that is typically 10 years. After 10 years, a “flip” occurs under the partnership arrangement at which time the project company receives an agreed portion of the economic benefits of the project (after-tax internal rate of return). A complex area of tax and partnership law, the IRS has promulgated Rev. Proc. 2007-65 (I.R.B. 2007-45) to create a “safe harbor” (no IRS letter ruling required) for partnerships to use the partnership flip structure for wind projects. When compared to a 20 percent (plus) RV risk in a lease under the tax guidelines, the typical 5 percent risk after the flip seems far more palatable for most tax equity sources. Further, the partnership flip structure is well understood from extensive use, unlike leasing wind facilities.
- Accounting: Due to a pending joint lease accounting project of the International Accounting Standards Board and the Financial Accounting Standard Board, the leveraged lease accounting treatment currently available under the Statement of Financial Accounting No. 13 (FAS No. 13) will likely not survive.
*Warning: Accordingly, as a sponsor or lessor you should evaluate the accounting implications of using a leveraged lease structure before committing to do so. No one knows whether the accounting change will be retroactive.
The result is likely to be the end of most off-balance sheet accounting for lessees and the spreading of income over the lease term for lessors in place of accelerated income in the early years of the lease (for lessors). The lease accounting project is targeted for completion in 2011.
*Techincal Points: Leveraged lease accounting in effect today is desirable as the book asset is net of the nonrecourse debt and the income pattern matches the economics of the lease. A lessor amortizes earnings using an after-tax yield (multiple investment sinking fund or MISF yield) against the net investment recognizing the after-tax cash flows in the deal. Under a leveraged lease, the lessor receives large tax benefits and income in the early years. The tax benefits have magnified under ARRA by the application of such tax benefits as accelerated depreciation and the cash grant. Income then drops rapidly in the later years, typically to zero for much of the term, as the net cash investment is fully recovered. Even during the recovery period, the asset remains on the lessor’s balance sheet under a generally accepted accounting principles (GAAP).
When lessors, developers and lenders analyze the attributes of nonrecourse lending and leasing, they should find that leasing is technically feasible as a financing tool to fund wind energy projects. Despite any positive outcome of such an analysis, the current market has predominantly resisted leasing based upon unacceptable RV risk, complexity and lengthy lease terms, all when compared to the benefits of loans.
With capital in such short supply, willing lessors may yet be able to come to the table (where cash is king), and close transactions that lenders cannot or will not do or at least support transactions with needed capital that lenders will not provide. Like any lease or financing agreement, if an equipment or facility financier meets its hurdles for after-tax yield and cash flows, the wind energy markets may yet see and accept a surge of equipment financing/leasing of wind energy facilities/equipment that is competitive, viable and profitable. Wind energy development will almost certainly regain its momentum in the next year or so. As it does so, equipment finance/leasing can play an important role in financing wind projects, but only if all parties decide to make it work for them.
Thanks to Bill Bosco, president of Leasing 101, for his review and editing of the accounting aspects of this article, to George Schutzer, co-chair of the Tax Group at Patton Boggs LLP, for his review of the tax portions of this article, and to Lauren Hill, senior vice president of Mesirow Financial, for providing advice on appraising wind energy facilities.
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2. Foreclosures on Wind Farms in Texas Present Complex Sales Tax Issues
Texas is not alone. Virtually every state with a sales tax needs your money, and will pursue you to collect it.
Texas generally imposes an 8.25 percent sales tax upon the sale of tangible personal property. No sale of tangible personal property escapes the sales tax unless it is exempt under the Texas Tax Code and Administrative Code. In contrast, Texas does not impose any real property transfer, sales or "stamp" taxes on any sale of real property.
*Warning: In any foreclosure of wind farm project financing, which may involve real and personal property (and the two mixed together), sales tax presents unique and fact-intensive issues, so significant that, as a lender or project sponsor/borrower, you should closely evaluate sales tax costs, if any, early in the process, to avoid a very expensive mistake.
Sale by Lender or Defaulting Project Company to Third Party After Foreclosure
Texas sales tax laws generally provide that if a lender repossesses secured property through foreclosure, and then sells the property to a third party, the sale of taxable items to the third party is subject to Texas sales tax. See Texas Comptroller Decision No. 24,967 (08/17/1989), Texas Comptroller Decision No. 16,489 (04/22/1987).
If the sale of the taxable items qualifies as an “occasional sale” by the borrower, a third party purchases taxable items directly at a foreclosure sale and the lender never takes title to the taxable items, then the sale of the taxable items to the third party should not be subject to Texas sales tax. See Texas Comptroller Decision No. 28,350 (02/23/1993); Texas Comptroller Decision No. 12,380 (12/02/1982). In other words, an occasional sale is exempt from Texas sales tax. See Texas Administrative Code Section 3.316(a).
A lender can execute documents on behalf of its borrower as its agent at the foreclosure sale or through a strict foreclosure. By doing so, the lender does not take title to the property itself. If the sale by the borrower (directly or through the lender as its agent) qualifies as an occasional sale, the sale to the third-party buyer may not be subject to Texas sales tax. See generally Texas Comptroller Decision No. 42,137 (01/31/2003).
Section 6.20 of the Texas Uniform Commercial Code (UCC) permits strict foreclosures (secured party directly takes title to collateral) and Section and UCC Section 6.10 permits foreclosures (commercially reasonable public or private sales). These provisions apply only to personal property (not real property). Transfers of real property in Texas must be foreclosed through a public sale process with rules separate from the UCC.
*Term to Know: An “occasional sale” includes two alternate definitions. First, the sale of one or two taxable items in a 12-month period by a person who does not hold himself out as engaged in the business of selling taxable items is an occasional sale. See Texas Administrative Code Section 3.316(b)(1). Second, Texas Administrative Code Section 3.316(e)(1) provides that "[a]ny transfer of all or substantially all the property [(at least 80 percent of the property)] held or used by a person in the course of an activity, when after such transfer the real or ultimate ownership of such property is substantially similar [(more than 80 percent common ownership between the transferor and transferee)] to that which existed before such transfer, is an occasional sale." This alternative form of occasional sale exemption should be available to a borrower upon a transfer to its affiliate, regardless of whether the business is currently being operated and whether the borrower or affiliate-purchaser holds a Texas sales tax permit (as discussed below).
Tax Consequences of Holding a Sales Tax Permit on Sale of Entire Business
If a borrower holds a Texas sales tax permit, then the borrower cannot claim the occasional sale exemption for sales made during the ordinary course of its business. However, the sale of the entire operating assets of a business conducted by the borrower is a completely different type of transaction under applicable sales tax laws.
The sale of the entire operating assets of a business is not a sale in the ordinary course of the seller’s business. In that case, even if the borrower (seller) holds a Texas sales tax permit, the sale of the entire operating assets of its business in a single transaction to a single purchaser can still qualify as an occasional sale. If the sale qualifies for the occasional sale exemption, the sale of the entire operating assets should be exempt from Texas sales tax. See Texas Administrative Code Section 3.316(d)(1). Conversely, if a purchaser holds a Texas sales tax permit but the seller claims the occasional sale exemption under Texas Administrative Code Section 3.316(i) with respect to sales of items in the ordinary course of the seller’s business, then, unless the seller relies upon its sale tax permit or another exemption, the purchaser is required to accrue and remit sales tax on the taxable personal property purchased in the transaction.
Sales Tax Imposed on Sale of Electricity from Wind Farm
The sale of electricity may be subject to sales tax in the ordinary course of an operating business of a wind farm. In general, the ultimate purchasers of electricity pay sales tax unless a specific exemption applies based on the intended use of the electricity. See Texas Administrative Code Section 3.295(c).
When a wind farm project becomes operational, it sells electricity in the ordinary course of its business. Unless the purchaser obtains a Texas sales tax permit applicable to the sale of electricity by the project, the purchaser would be required to accrue and remit sales tax on any taxable items transferred with the wind farm project, even though the seller is able to take advantage of the occasional sale exemption contained in Texas Administrative Code Section 3.316(b)(1), unless certain eligible individual items such as machinery or equipment that are transferred as personal property can qualify for the manufacturing exemption.
*Tip: To determine whether the sale by the borrower of the wind farm (in whole or in parts) can qualify as an occasional sale, you will need to know whether:
- the borrower holds a Texas sales tax permit;
- the borrower has sold any taxable items in the past 12 months;
- the borrower operates the wind farm as a business;
- the borrower has any history of operation prior to the foreclosure sale;
- the sale of the assets at a foreclosure sale could be sales of such assets piecemeal;
- the sale of the assets at a foreclosure sale would be the sale of the entire operating assets of the borrower’s business to one buyer.
Applying these principles to the following hypothetical foreclosure scenarios should result in the conclusions stated in the hypothetical:
- Lender Buys at Foreclosure Sale. The purchase by the lender at the foreclosure sale of taxable items should not be subject to sales tax as long as the borrower and the transaction are eligible for an occasional sale exemption. If the lender then sells the taxable items to a third party, the subsequent sale to the third party will be subject to Texas sales tax.
*Warning: The lender will generally not be eligible for an occasional sale exemption because repossession and sale of property is considered to be part of the lender's ordinary business.
However, one exception to this general rule is that if the lender operates the business as a separate and identifiable segment of its business by keeping separate books of account or record of the income and expenses attributable to the separate identifiable segment, then the lender could later claim the occasional sale exemption contained in Texas Administrative Code Section 3.316(d)(1). Further, it is possible certain of the assets of a wind farm could still be eligible for the manufacturing exemption if first repossessed by the lender and then sold to a third party.
- Lender Creates SPE, Debt Assigned and SPE buys at Foreclosure Sale. No sales tax is imposed where each of these sales qualifies as an occasional sale: (a) the purchase by the special purpose entity (SPE), such as a limited liability company at the foreclosure sale of the taxable items; and (b) sale by the SPE of the taxable items to a single third-party purchaser in a single transaction as long as the SPE never holds a Texas sales tax permit.
*Warning: If the SPE claims the occasional sale exemption contained in Texas Administrative Code Section 3.316(b)(1), as the purchaser, you may be required to accrue and remit sales tax on the sale of taxable items in the transaction where you intend to operate the wind farm and are required to obtain a Texas sales tax permit.
You should ask: (1) Are the assets being sold in the ordinary course of operation of the wind farm business? (2) Are there any exemptions, other than an occasional sale exemption, available with respect to such sales? If the answer to both questions is “no,” you should contact your tax advisor promptly to determine the best course of action regarding the accrual and payment of sales tax.
Sales tax may be imposed if the SPE sells the taxable items to multiple buyers in separate transactions because the SPE will make more than the two permitted sales that entitle the seller to use the occasional sale exemption. When the SPE makes the third sale of taxable items, it becomes ineligible for the occasional sale exemption. See Texas Administrative Code Section 3.316(b)(1).
- Third Party Buys Assets at Foreclosure Sale. The sale to the third party will not be subject to Texas sales tax as long as the borrower and the transaction are eligible for an occasional sale exemption. The lender can act as agent of the borrower with respect to the sales and related documents (and in no other capacity).
- Borrower or Affiliate Forms SPE to Buy Assets at Foreclosure Sale. The sale by the borrower to an SPE related to the borrower should not be subject to Texas sales tax as long as the borrower and the transaction are eligible for the occasional sale exemption contained in Texas Administrative Code Section 3.316(e)(1) (discussed above). The lender can act as agent of the borrower with respect to the sales and related documents (and in no other capacity).
- Borrower's Equity Interests are Sold Outside of Foreclosure Sale. The sale of the equity interests of the borrower should not be a sale subject to Texas sales tax as it would be a sale of intangible property which is not a taxable item.
- Borrower's Assets are Sold Outside of Foreclosure Sale. The sale of taxable items to a single third-party purchaser in a single transaction will not be subject to Texas sales tax if the borrower and the transaction are eligible for the occasional sale exemption.
*Warning: If the wind farm has not been operational, the borrower claims the occasional sale exemption contained in Texas Administrative Code Section 3.316(b)(1), and no other exemptions are available, the third-party purchaser may be required to accrue and remit sales tax on the sale of taxable items in the transaction.
Wind Farm Real Property Transfers Not Subject to Sales Tax
The greatest tangible asset value of a wind farm consists of its wind turbines affixed to the underlying real property. Accordingly, the wind turbines should be considered as an improvement to the realty and not considered tangible personal property if transferred with a sale of the realty. As a result, very little of the value of the assets being transferred may even be subject to Texas sales tax or eligible for an occasional sale exemption.
The following test has been adopted by the Texas Comptroller in Texas Policy Letter Ruling No. 9709746L (09/26/1997) for determining whether personal property becomes an improvement to realty and, thus, a part of real property:
The basic and long established Texas test for determining whether personal property placed upon land or real estate becomes a fixture, such that the property becomes merged into the land (or realty) as a permanent accession to the real property, or retains its identity as personalty depends on the answer to the three questions below. If “yes,” to each question, the personalty becomes an improvement to realty; if “no,” the personal property remains tangible personal property potentially subject to sales tax in the absence of an applicable, valid exemption:
- Was there a real or constructive annexation of the personal property to the real property?
- Was there a fitness or adaptation of the personalty to the realty?
- Did the party making the annexation intend for the personal property to become a permanent accession to the real property?
The answer to above tests should be “yes.” The wind turbines and towers attached to the realty and sold with the realty in a foreclosure (or other) sale should be considered an improvement to realty and a part of the realty.
*Technical Point: In at least one private letter ruling, the Texas Comptroller has considered wind turbines as an improvement to realty. See Texas Policy Letter Ruling No. 200002081L (02/29/2000).
As a result, from a Texas sales tax perspective, the sale of wind turbines and towers attached to realty in a real property foreclosure sale should not be treated as a sale of tangible personal property.
The difficulty of a foreclosure of a wind farm will not be lost on anyone in that situation. To avoid making matters worse in Texas, and to properly structure the remedy, whether by a sale by foreclosure or otherwise, the parties must carefully evaluate the sales tax implications of the transaction. At 8.25 percent of the sale value, a mistake can cost millions of dollars that the Texas taxing authorities will only be too happy to collect.
Thanks to Jason Forshee, a tax partner in the Dallas office of Patton Boggs LLP for contributing this article.
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3. BLFN’s Case & Comment: In re Winstar Communication, Inc.: Avoiding an ‘Insider’ Preference
You may have received an insider preference under federal bankruptcy law, and not even suspected it.
On February 3, 2009 the Third Circuit Court of Appeals expanded the definition of an “insider” for the avoidance of preferences by trustees in bankruptcy in the case In re Winstar Communication, Inc. 554 F.3d 382 (3d Cir. 2009). This expanded definition could trap many unsuspecting creditors on the “inside” of a debtor’s bankruptcy.
BACKGROUND: In October of 1998, Winstar Communications Inc. entered into a “strategic partnership” with Lucent Technologies, Inc. At that time the parties entered into a $2 billion credit facility in which Lucent essentially agreed to help finance, provide equipment and software for and construct Winstar’s global broadband telecommunications network. Under the terms of the agreement Winstar agreed to purchase between 65 and 75 percent of its equipment and services from Lucent.
In May 2000, Winstar obtained additional financing of $1.15 billion. Winstar used the money to pay off Lucent’s loan. Subsequently, the parties entered into another credit facility because Lucent desired to keep its good customer relationship with Winstar. The second credit facility imposed several significant financial covenants on Winstar. Shortly thereafter, in December 2000, Lucent forced Winstar to pay nearly $200 million of new third-party financing proceeds to pay down the second loan. Winstar filed bankruptcy on April 18, 2001, more than 90 days, but less than one year, after the payment to Lucent.
The bankruptcy trustee sought to avoid the payment to Lucent as a preference. Because the transfer occurred more than 90 days, but less than one year, before the filing of the bankruptcy petition, the transfer could only be deemed a preference if Lucent was an “insider” of Winstar. The bankruptcy court found that Lucent was both a statutory and a nonstatutory insider and, therefore, avoided the transfer to Lucent as a preference. The court of appeals upheld the lower court’s avoidance of the transfer as a preference, but tweaked some of the reasoning for the ruling.
ISSUE: Was Lucent an insider whose payments could be avoided under the federal Bankruptcy Code?
OUTCOME/DECISION: Yes. Lucent was an insider of Winstar whose control over the debtor made it an “insider” under applicable nonstatutory principles. The federal Bankruptcy Code allows a bankruptcy trustee to “avoid” (meaning invalidate) and recover for the benefit of the estate, transfers made between 90 days and one year before the filing of the bankruptcy petition, “if such creditor at the time of such transfer was an insider…” 11 U.S.C. § 547(b)(4).
LAW OF THE CASE: There are two types of “insiders” in bankruptcy cases:
- Statutory: Section 101(31)(B) states that the term “insider” for a corporation includes: (i) director of the debtor; (ii) officer of the debtor; (iii) person in control of the debtor; (iv) partnership in which the debtor is the general partner; (v) general partner of the debtor; or (vi) relative of a general partner.
- Nonstatutory: Since the Bankruptcy Code’s definition of “insider” merely says “includes,” courts have identified a category of creditors who fall within the definition, but outside of any of the above-listed categories.
The principle question for the court of appeals was what is the legal standard for “insider”? The court agreed with Lucent’s assertion that, in order for a creditor to constitute a statutory insider as a “person in control,” the creditor must exercise actual day-to-day managerial control. However, the court rejected Lucent’s argument and held that day-to-day control is not necessary for an entity to be a nonstatutory insider. Rather the question is “whether there is a close relationship between the debtor and creditor and anything other than closeness to suggest that any transactions were not conducted at arm’s length.”
The court found numerous examples of Lucent exerting excessive control over Winstar, indicating that the relationship was not kept at arm’s length and that Lucent could coerce Winstar into transactions not in Winstar’s best interest. For example, Lucent controlled many of Winstar’s decisions regarding the build-out of the communications network and forced the purchase of its goods or software well before the equipment was needed (or never needed at all), sometimes at inflated prices and usually to assist Lucent in reaching quarterly revenue goals. Lucent treated Winstar as a captive buyer for its goods and used Winstar as a means for Lucent to inflate its own revenue. In sum, the court found that Lucent had come to dominate the relationship between the parties by December 2000.
Therefore, the court affirmed the lower court’s decision that Lucent was a nonstatutory insider since it had dominated the relationship to the extent that transactions were not made at an arm’s length.
*Commentary: Creditors must be cautious in light of the court’s ruling in Winstar. If a creditor becomes too closely involved in the business of its debtor, as occurred in this case, and the creditor, like Lucent, begins exerting too much control, flexing its muscles as a creditor and other capacities, or coerces its debtor into taking a particular action, the court may transform the unwitting creditor into a nonstatutory insider subject to the extended one-year preference period. Even if a contract allows a creditor to exert some level of control, such an argument may not be persuasive if there are other examples of the creditor exerting control over the debtor’s business or using the debtor for its own purposes which are not in the debtor’s best interests. This case should not be regarded as appropriate to everyday, arms length lender/debtor relationships, even in a default situation. This case demonstrates that when a creditor (Lucent) exercises an extremely high and atypical level of control over a debtor (Winstar), the creditor should look at this case as applicable to its actions. Lucent acted as a creditor; supplier of goods, services and software; contractor and customer to Winstar and its various affiliates and subsidiaries. The $2 billion line of credit Lucent initially provided Winstar had a material impact on Lucent’s financial statements and Lucent exerted significantly more control than is commonly permitted under most loan documents. It was the combination of these factors that lead to the Third Circuit’s decision in this case.
It is extremely important that debtors and creditors conduct all the transactions with each other at arm’s length. If a creditor finds itself in a powerful position over its debtor, the creditor should be careful prior to exerting its will on the debtor because doing so could turn the creditor into an “insider” with an accompanying extended preference period. The reach of the Winstar decision remains to be seen, but creditors who play the leverage game aggressively should be conscious of an increased risk of holding a loosing hand.
Thanks to Austin Henley of the Dallas office of Patton Boggs LLP for contributing this article and thanks to Jeff LeForce for reviewing this article.
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4. Finance 101: What Is a "Reorganization in Bankruptcy?"
Bankruptcy filings are on the rise and discussions regarding bankruptcy are ever more common in mainstream business. Despite the increased utilization of bankruptcy as a restructuring tool, often even high-level executives do not understand the basic terminology used in the restructuring world to describe the bankruptcy process.
One of the most misunderstood concepts of the bankruptcy process is how to characterize the proceeding itself. People often ask: "Is the bankruptcy a reorganization or a liquidation?" The truth is the lines are often blurred as to that fact early in the case.
All bankruptcy proceedings are governed by federal law, which is referred to as the bankruptcy code. The bankruptcy code is found at Title 11 of the United States Code. 11 U.S.C. §§ 101, et seq. Within Title 11 are certain numbered chapters that, among other things, define the persons or entities eligible to use specific provisions of the bankruptcy code. Those chapters include Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13 and Chapter 15.
Chapter 9 is a section of the bankruptcy code which provides for reorganization of a municipality while Chapter 12 is limited to family farmers and fisherman. Chapter 13 is limited to consumers, and requires the consumer debtor to repay some amount to his or her creditors.
*Tip: A business is not eligible for Chapter 13. Chapter 15, on the other hand, provides a mechanism for dealing with cross-border insolvencies.
The two chapters of the bankruptcy code that are often confused are Chapters 7 and 11. Chapter 7 is commonly referred to as "straight liquidation" because the underlying purpose of Chapter 7 is to liquidate available assets to pay creditors, and a Chapter 7 debtor cannot technically reorganize in the traditional sense of emerging from bankruptcy with restructured debt.
*Tip: Chapter 7 can be utilized by both businesses and consumers, but historically has been more heavily weighted toward consumer use.
The primary distinctions between Chapter 7 and Chapter 11 lie in who controls the process. In Chapter 7, upon the filing of the proceeding a trustee is appointed to oversee the liquidation of the debtor's assets. The trustee is typically chosen randomly from a pool of eligible panel trustees in the district in which the case is filed.
In the case of a business, the trustee typically does not run the company, but can do so for a limited time if necessary. The important fact is the trustee takes over control and oversight from an entity's board and management. Because Chapter 7 requires an affirmative release of control by a company's board and management, a voluntary Chapter 7 filed by a business is seen as a sign that little chance exists for payment of creditors.
Chapter 11 is referred to as the business reorganization chapter of the bankruptcy code. In a Chapter 11, the company's management and board typically remain in control of the process. As a result, in most cases, a company continues to operate post-filing on a somewhat "business as usual" basis.
*Tip: A common misconception is that a trustee is appointed in every bankruptcy case to take control of the company. In reality, no trustee is appointed in most Chapter 11 proceedings.
While bankruptcy court approval is necessary for many operational decisions, practitioners and courts have developed an efficient and effective process for obtaining such approval with minimal interruption to a debtor's business operations.
But the filing of a Chapter 11 by a business does not mean that it will "reorganize" as that term may be commonly understood. In fact, many Chapter 11 cases begin with an immediate sale of substantially all of the debtor's assets.
*Tip: Sales in bankruptcy are commonly referred to as "363 sales" (sales of property under 11 U.S.C. § 363 of the federal Bankruptcy Code). See Fast-Tracked Sales Under Section 363 of the Bankruptcy Code Imperil Lessor Interests by Michael Richman and Mark Salzberg of the Patton Boggs LLP Bankruptcy and Restructuring Practice group in New York and Washington, DC, respectively.
In other words, a Chapter 11 often begins with a "liquidation." In years past, many asset sales in Chapter 11 were followed by a conversion to Chapter 7. As a result, the board and management of the debtor ceded control over the debtor's assets after completing a sale which was often negotiated well in advance of the filing. The reason many of those cases converted to Chapter 7 was that there were very little proceeds from the sale after the debtor's secured lender was paid, and therefore the continued expense of a Chapter 11 proceeding was not warranted.
Today, most Chapter 11 proceedings, even those where substantially all of the assets are sold, end with court approval of some sort of a reorganization plan. A plan is simply a written document that provides for payment of creditors and interest holders in accordance with the provision of the bankruptcy code. What used to be referred to as a "plan of reorganization" today may take many forms, including simply distributing proceeds to creditors after a liquidation sale. The plan may also restructure debts and provide for continued operation moving forward. The plan process offers creditors an opportunity to review and take a position as to the distribution of property and the future operations of the debtor in the case of a reorganization. The plan process provides closure to a proceeding, but such closure rarely comes early on in the case.
*Warning: A common misconception among many people is that a debtor has a plan or files a plan when the bankruptcy proceeding begins. In most cases a plan of liquidation or reorganization is not prepared until many months into the case. In fact, it is not uncommon in large cases for the plan process to take more than a year.
To demonstrate your knowledge of bankruptcy law, when the question is posed whether a case is a reorganization or liquidation, the answer may very well be: We will have to wait and see.
Thanks to Brent McIlwain, a partner in the Dallas office of Patton Boggs LLP, who practices in the Bankruptcy and Restructuring group.
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About Patton Boggs LLP; PB Capital Resource Center; Publications, Speeches and Radio Interviews; Upcoming Speech: Natural Gas Storage, Jan. 2010 (Platts)
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.
PB CAPITAL RESOURCE CENTER
Capital Markets Web site– PB Capital Markets is the firm’s dedicated Web 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 EST and 9:00 a.m. PST 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.
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.
"Base Gas Hedging and Structuring Base Gas Leases" – Platts’ Gas Storage Outlook, 8th Annual, Hilton Americas, Houston (January 13-14, 2010)
Publications, Speeches and Radio Interviews
The following is a partial list of David G. Mayer's articles (individual or co-written), speeches and radio show appearances:
- Requirements and Options for Leasing and Financing Wind Energy – Panel: Green Finance: Opportunities in Wind, Solar and Infrastructure Financing, ELFA 48th Annual Convention, Manchester Grand Hyatt, San Diego (October 19, 2009)
- 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 on July 30, 2009, regarding the significant challenges and trends in business aviation today.
- 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 G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)
© David G. Mayer 2009
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