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A popular business model for photovoltaic panel manufacturers is to develop a PV project and sell that developed project to a buyer under a stock or asset purchase and sale agreement (PSA). As part of that sale, the buyer agrees that the seller’s affiliates will provide fully wrapped turnkey engineering, procurement and construction (EPC) services utilizing another affiliate’s panels under an EPC contract, as well as short- or long-term operation and maintenance services under an operation and maintenance (O&M) agreement.

This business model and similar variations exist both in the domestic and international PV markets, thus facilitating the distribution of sellers’ PV panels while providing purchasers with fully developed - and occasionally financed - projects.

The relationship created by this model raises unique contractual issues in PV mergers and acquisitions with respect to limits on liability resulting from the different roles that the seller and its affiliates assume in the overall transaction.

This article describes customary limits on liability in PV PSAs, EPC contracts and O&M agreements and identifies liability issues from the buyer’s/owner’s and seller’s/contractor’s perspective in light of this transaction structure.

The PSA will contain provisions to limit the seller’s liability for post-closing indemnification claims by way of a deductible (where damage recovery is permitted only above a specified dollar threshold after that threshold is exceeded) or a tipping basket (where damage recovery is permitted from the first dollar after a specified dollar threshold is exceeded).

The PSA will also, on occasion, contain provisions to limit the seller’s liability for smaller claims through a minibasket, where individual claims must exceed an additional, de minimis dollar threshold before they are applied to the deductible or tipping basket.

The PSA may also contain provisions to limit the seller’s overall liability. The cap on liability is based on a percentage of the purchase price. If closing occurs simultaneously with the initial drawdown under the construction financing agreements, the buyer’s obligation to make equity contributions for the lender’s benefit could increase the cap.

Alternatively, the cap might account for the contract price under the EPC contract - in which case, the PSA and EPC contract aggregate liabilities applied to that or another cap.

The PSA often contains additional provisions to limit liability. These can include various survival periods, waivers of consequential and other damages, insurance-claim requirements, anti-sandbagging provisions and provisions relating to the seller updating the PSA’s disclosure schedules for events occurring between signing and closing.

 

Liability limits

The EPC contract will have provisions to limit EPC contractors’ overall liability, in addition to containing multiple subcaps on liquidated damages for construction start, block turnover and substantial completion schedule guaranties and performance guaranties. The EPC contract typically has a provision to limit EPC contractors’ overall liability to 100% of the contract price prior to substantial completion. This cap occasionally decreases after substantial completion of the entire PV facility.

The contract will also contain detailed provisions regarding when and how the EPC contractor may require the owner to issue a change order. In general, the EPC contractor may be entitled to a change order for additional money and time if an owner-caused delay or other excusable event occurs. The contractor might be required to prove that the increased costs or delays are sufficiently material to receive a change order, though this materiality threshold does not always apply to owner-caused delays.

Materiality can be numerically defined with respect to costs and length of delay. However, it is frequently left to a subjective, undefined materiality standard.

Under the O&M agreement, the overall limit on liability is often substantially lower than under the PSA or EPC contract and typically based on a percentage of the contract fees earned either annually or over the contract term. The O&M agreement will also contain provisions regarding change orders similar to the provisions in the EPC contract. However, it is unusual to see a materiality threshold for such change orders.

EPC contractors often do not want to assume risk for hazardous materials existing before owners’ issuance of the full notice to proceed or initial site mobilization under the EPC contract. If issues regarding such pre-existing hazardous materials arise, contractors are typically required to stop work in the affected area. But in this case, the owner typically issues a change order to remedy cost increases and delays resulting from those pre-existing hazardous materials.

Further, a PV EPC contractor will assert rights for indemnity from the owner for associated liabilities. Under the PSA, the seller will likely make certain environmental representations and warranties about the PV facility site. Accordingly, what happens if, under the PSA, sellers’ representations and warranties are untrue as a result of events that trigger a change order or indemnity claim in favor of EPC contractors under the EPC contract?

First, will any threshold under the PSA hinder or prevent buyers’ recourse against sellers if EPC contractors issue a change order to owners? The materiality threshold for change orders under the EPC contract, if any, usually are subjective absent numerical thresholds, potentially being interpreted as, or actually being, lower than the threshold(s) under the PSA.

Additionally, EPC contractors will argue that change orders due to pre-existing hazardous materials should not be subject to a materiality threshold (as opposed to claims for force majeure, change in law and certain other excusable events), given that such materials are generally within typical owners’ control. Further, hazardous material indemnities in EPC contracts are not customarily subject to materiality thresholds.

What happens if the pre-existing hazardous material claims - either individually or combined with other claims - exceed the PSA’s liability cap? The seller’s position is that the limit on liability is customary and should not be circumvented simply because the seller (or its affiliate) is also the EPC contractor.

The buyer’s position, however, is that the seller should not sell a flawed project to the buyer while realizing massive profits under the EPC contract and that the seller’s economics for the entire transaction should be relevant.

 

 

Permits and rights

Overall, the buyer risks nonrecourse against the seller under the PSA in the event the seller’s affiliate issues a claim against the owner resulting from the seller’s wrongdoings. To address these issues, the parties could consider agreeing to the following, with respect to cross-liability claims:

• That the EPC contractor is only entitled to additional time for the delay but will not receive money either from a change order or indemnification;
• That the EPC contractor is entitled to additional time for the delay and a change order for incremental performance costs but may not receive indemnification;
• That the EPC contractor is entitled to time for the delay but is not entitled to incremental performance costs under a change order until a predetermined amount is exceeded; or
• That the cap and thresholds do not apply to such change orders or such indemnification claims, or change orders and indemnification claims are precluded, giving the buyer a shield against affiliated claims.

Pre-existing hazardous materials are just one example of limits on liability issues under the PSA in this transaction structure. In light of customary owner obligations under PV EPC contracts, similar issues potentially arise in connection with the representations and warranties in the PSA regarding project permits, real property rights, material contracts, no material adverse effect and no litigation, as well as the 10b-5 representation and warranty.

O&M contractors will also likely assert change order and indemnification rights and rights to charge for additional services under the O&M agreement that could result in similar cross-liability issues between the O&M agreement and the PSA.

When constructing a relatively large PV facility, it is common for the EPC contractor to turn the facility over to the owner in blocks as completed. In this case, the O&M contractor operates those blocks, while the EPC contractor constructs the remaining facility. Accordingly, two affiliates perform closely related services side by side under separate contractual relationships.

EPC contracts and O&M agreements may also provide that the contractor indemnifies the owner for certain liabilities resulting from acts and omissions of the contractor’s affiliates. So, the indemnities may allow the owner to recover from the EPC contractor certain liabilities caused by the O&M contractor (and vice versa).

Moreover, if the owner cannot clearly identify the culpable party, the owner will sue both parties under their respective agreements. Not only is the EPC contract’s limit on liability typically larger, but third-party indemnification obligations are also usually carved out of the EPC contractor’s limit on liability - but not necessarily the O&M contractor’s limit on liability.

The buyer usually prefers suing the EPC contractor for culpable acts or omissions of the O&M contractor in order to evade lower limits on liability under the O&M agreement. In any case, the agreements should net damages recovered from affiliates or otherwise clearly negate double recovery in case a claim is brought under both the EPC contract and O&M agreement.

Indemnities often cover acts or omissions of employees and subcontractors. If those persons worked in connection with the PV facility before closing under the PSA and continue to work for the EPC contractor or O&M contractor, the EPC contractor’s and O&M contractor’s indemnification obligation might inadvertently include pre-closing liabilities if those liabilities are not narrowly tailored to the work performed under the EPC contract or O&M agreement.

If the indemnities pick up acts or omissions of affiliates, the buyer might additionally argue that the indemnities cover acts or omissions of prior affiliates if the applicable liability arose during their affiliation.

Thus, certain owner liabilities could be subject to indemnification under the EPC contract and O&M agreement, when the EPC contractor and O&M contractor would expect that such liabilities only are covered by the PSA.

In these cases, buyers are mainly concerned about the enforcement hassle resulting from each seller’s affiliate separately arguing that a claim is brought under the wrong transaction document. The parties should consider allocating enforcement costs, plus interest and other costs, to compensate buyers/owners for their trouble.

Additionally, the transaction documents could consolidate dispute resolution proceedings under all the transaction documents, and thought should be given to how to choose an arbitration panel in the event there are multiple parties, some of whom may be affiliates.

Other cross-liability issues exist as well. For example, the buyer should consider the cross-termination rights between the EPC contract and O&M agreement, as well as liability for demonization costs under the O&M agreement if termination of the O&M agreement is in connection with terminating the EPC contract due to the EPC contractor’s default. The EPC contractor, on the other hand, should consider related issues affecting force majeure and change order claims.

 

Consequential damages

The buyer will want to recover amounts payable under the EPC contract and O&M agreement from the seller under the PSA if such amounts result from a breached representation, warranty or covenant of the seller under the PSA.

The contracts between sophisticated parties usually contain a provision for waiver of consequential damages. The exact meaning of consequential damages is somewhat amorphous and determined on a state-by-state basis. The seller could argue that damages owed under the EPC contract and O&M agreement are consequential in nature and thus are expressly barred by such a waiver in the PSA.

Waivers of consequential damages occasionally contain an exclusion for amounts payable to third parties that are otherwise indemnifable under the applicable agreement. Even if that carve-out exists, a court or arbitrator could interpret the EPC contractor or O&M operator as “not true” third parties, given their affiliation with the seller and that the EPC contract and O&M agreement are integral to the transactions under the PSA, possibly even being attached to the PSA.

Therefore, buyers should expressly provide in the PSA that they may seek damages from sellers’ breaches to redress liabilities owed under the other transaction documents.

In summary, there are several potential legal issues unique to the popular marketing model for PV panel manufacturers, which develop and sell projects together with their EPC and O&M services. Derivations of this structure also exist and could create similar issues.

The importance of negotiating limits on liability cannot be overstated, whether on the buyer or seller side of the deal. The parties should carefully consider the issues previously described, as well as others, when negotiating a deal utilizing this or a similar structure. S

 

Drew Baldinger is an associate at the Houston office of Andrews Kurth LLP, where he has particular experience representing developers, electric utilities and investors in connection with solar projects. He can be contacted at (713) 220-4118.