Negotiating solar contracts in uncertain times
As we begin 2022, the renewable energy industry in the United States has much for which to be thankful: A strong demand for clean power, increasing recognition of the need for an accelerated energy transition, and a thriving, successful base of developers and contractors working toward this common goal.
Despite these successes, our PV industry continues to face significant market volatility and daunting challenges, including ongoing global supply chain and production issues, tariff and trade disputes, and commodity price volatility. Project development requires multi-year planning to coordinate successful construction and long-term operation, and parties often execute agreements well in advance of either. Sophisticated developers, contractors and financing parties in the PV industry are increasingly implementing innovative contracting strategies to manage the risks of our uncertain world.
Roadmaps for execution
Contracts aren’t usually known for flexibility – in fact, quite the opposite. Too often parties view contracts as “set-it-and-forget-it” paper in a file drawer, rather than a roadmap for execution. But especially in the development and construction industry, contracts regularly contain provisions excusing performance or establishing alternative obligations upon occurrence of certain future circumstances, including force majeure (an event that cannot be anticipated or controlled), change in law, and other excusable events. Understanding the context and framework of these provisions – and ensuring they are appropriately negotiated to allocate unforeseen or unpriced risks in a rapidly-changing industry – is key to navigating this volatile market.
The contract negotiation period is often known as the “honeymoon phase” of a business relationship, where parties are optimistic and confident in their mutual success. Initiating what-if discussions of potential future complications in early negotiations may be viewed as unnecessarily negative – when it is in fact critical to establishing open communication and mutual understanding needed for future problem-solving and long-term success. The way parties discuss and account for unknown and often unpredictable risk – whether the risk is legal, political, economic or technology-based – will ultimately determine which parties maintain and build upon initial achievements to become industry leaders as the PV industry continues to expand and mature.
From the legal perspective, we face significant regulatory uncertainty nationally as well as locally, as legislators begin to contemplate and directly address the challenges of grid electrification.
Nationally, Congress continues to debate several key bills, which if enacted will drastically alter the business of renewable energy (including President Biden’s proposed Build Back Better agenda, which anticipates extended investment tax credits incorporating prevailing wage standards and incentivizing domestic manufacturing).
The state and local regulatory framework in the U.S. often presents a patchwork of sometimes-conflicting obligations for solar PV developers (particularly for independent power producers). As solar and storage projects are increasingly developed in new jurisdictions, state and local regulators often have varied interpretations of whether and how to apply laws and permitting requirements to these projects.
These legal risks are frequently the topic of project development discussions, and developers and contractors should consider various possibilities when negotiating contractual change in law provisions. Changes in law should be clearly defined – and should address whether changes in permitting and code requirements, or even changes in administrative interpretation of laws qualify as circumstances upon the occurrence of which the parties should revisit their project assumptions. Parties may consider negotiating alternative obligations and pre-agreed cost adjustments in the event, for example, a form of the proposed Build Back Better bill passes, and a project must be reconfigured to qualify for extended investment tax credits. Or, to account for more local risk, parties may want to specify agreed permitting obligations and provide for an extended schedule in the event a local authority having jurisdiction fails to timely issue required permits (an increasingly common issue due to COVID-19 impacts along with labor shortages).
Supply chain issues
Legal risk is often intertwined with political risk, and the PV industry is of course closely monitoring geopolitical events that we have recently seen result in significant supply chain constraints. Module suppliers have notably shifted sourcing of polysilicon away from China’s Xinjiang Uyghur Autonomous Region (XUAR) in reaction to U.S. Customs and Border Patrol’s Withhold Release Orders and the more recent Uyghur Forced Labor Prevention Act (UFLPA), which creates a rebuttable presumption that goods mined, produced, or manufactured in China’s XUAR were made with forced labor and are prohibited from import under Section 307 tariffs.
The UFLPA anticipates exceptions but there is (and will not be for some time) no established criteria for such exceptions. Industry agreements now commonly provide for supply chain traceability audits and wide-ranging penalties for any traced links to Xinjiang, and many parties understandably expressly exclude the UFLPA and its enforcement from change in law relief.
Read “U.S. House unanimously passes forced labor bill for Xinjiang region”.
Uncertainty around tariffs
On the political front, developers and contractors continue to monitor the uncertain application and potential extension of Section 201 tariffs. With the U.S. International Trade Commission’s recent determination that tariffs continue to be necessary to “prevent or remedy serious injury to the U.S. industry,” most developers and contractors procuring internationally sourced crystalline silicon PV modules are bracing for the financial impact of extended tariffs. Prior to this determination, much of the industry had assumed Section 201 tariffs would soon expire, and purchasers may not have built cost assumptions for extended tariffs into project cost modules. Many module supply agreements directly address and allocate tariff cost risk, although it is often difficult to assess the true direct cost impact of extended tariffs – and parties who initiate discussions regarding mitigation measures to avoid or minimize the impact of extended tariffs will be better positioned to manage this risk moving forward.
In addition, and prior to the Trump administration’s revocation of the exclusion of bifacial PV modules from Section 201 tariffs, many developers and contractors entered into module supply agreements anticipating those modules would be tariff-exempt. Although that assumption changed in October 2020, the recent November 2021 opinion from the U.S. Court of International Trade provides renewed optimism that bifacial modules should be exempt. Pending appeal of this opinion, both manufacturers and buyers are considering options for how to manage the cost impacts of tariffs that have been assessed, may be assessed, or that may be refunded.
Our uncertain political environment, especially as it involves international trade, continues to require parties to be agile and adapt to procurement constraints. It is not uncommon to have several contingency plans built into project contracts designed to manage these risks. In fact, engineering, procurement, and construction contracts for PV projects commonly delegate shared procurement risk between developers and contractors to manage both political risk and rapid technological change.
Component compatibility risk
A key challenge of any modern PV project involves ensuring compatibility of key components – technology-based risk that has only increased as today’s PV projects are paired with utility-scale battery storage facilities. Contract provisions requiring cooperation and certain shared responsibilities between PV contractors and battery storage integrators are becoming increasingly complex as developers seek to ensure comprehensive, reliable operation.
Similarly, hand-in-hand with technology-based risk is economic risk: As technology shifts and advances, some manufacturers and developers are better positioned to weather change than others. Established manufacturers with sufficient resources and stability to confidently manage long-term operational and warranty commitments are increasingly hard to find. This will continue to be an issue, especially as governments debate how to responsibly regulate eventual component recycling and decommissioning of PV plants. Even at higher initial expense, many parties insist on contractual rights to readily available spare and replacement parts over the estimated design life of a facility, and/or advance notice in the event a manufacturer plans to retire production of purchased components.
The economic impacts of COVID-19 have certainly increased challenges in the development and construction industry. To cite one recent example, skyrocketing prices of raw materials such as aluminum and steel over the last year have created significant constraints in procurement of racking equipment and tracker systems. Parties planning projects where trackers and racking will not be needed until 2023 may not be willing to commit to procurement costs within assumed project cost models due to today’s high cost of aluminum and/or steel.
That said, where parties anticipate future prices falling as supply chain constraints ease, it may be wise to negotiate a risk-sharing provision based on a designated commodity price index. This is often known as a “material escalation” provision, where contractors and suppliers hedge against future price increases by stipulating a pre-agreed price adjustment depending upon the future commodity price index value. In the PV industry, many parties are considering not only price increases for rising commodities costs but also price decreases to the extent today’s unusually high prices subside in the future.
Force majeure provisions
Negotiating appropriate force majeure provisions in contracts to best manage these risks can be a delicate balance. Force majeure provisions often provide excusability to the extent of discreet events related to COVID-19 that delay equipment delivery or prevent site access, but may not provide relief for field labor impacts due to social distancing requirements, vaccine mandates, or workforce shortages due to chronic widespread illness. Creative contracting options, including liquidated damages specifically tied to COVID-19 delay impacts on site and updated health and safety protocols for potential COVID-19 outbreaks, are necessary for realistic project planning.
Of course, there is no way to predict the future. The broad risks facing the PV industry at the beginning of 2022 are not likely to be the only risks we encounter this year – and as new risks arise, sophisticated parties will quickly adapt to manage them. Developers and contractors who make calculated decisions about multifaceted and complex risks, taking a long-term perspective, will ultimately be best positioned to succeed. This perspective cannot be obtained in a vacuum: it requires diligent input from informed stakeholders in every relevant expertise. Alas, it is also not achievable by way of a perfect contract negotiated by perfect counsel: It requires an honest, balanced contracting approach qualifying unknown risks and diligent daily post-execution management.
That said, here’s to another year’s adventure on the solar coaster – it is sure to be anything but dull!
Republished with permission. This article, "Negotiating solar contracts in uncertain times," was published by PV Magazine on January 3, 2022.