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Issues to watch for when negotiating a solar lease

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By J. Court Shipman

solar_mainSolar energy is booming in Virginia. Solar developers are approaching landowners with attractive proposals promising passive income more lucrative than traditional farming. However, landowners should remember that the prospect for higher returns is coupled with greater risk. Solar projects involve decades-long commitments that will be subject to risks inherent in energy and bond markets, construction projects and public policy. In fact, it is very likely that the individuals negotiating a solar lease will not be around when the lease expires. For these reasons, it is imperative that landowners carefully review and understand the terms of a proposed solar lease before committing their property for development. This article discusses some of the important legal issues counsel for landowners should consider when reviewing and negotiating solar leases.

Basic structure of transaction. Counsel should first understand the basic structure of the deal. Solar lease transactions are typically designed one of two ways, both of which give developers an opportunity to evaluate a landowner’s property, obtain necessary permits and arrange for the sale of the anticipated electrical power before committing to a long-term lease with the landowner. One deal structure is a basic ground lease that provides for reduced rent during a due diligence period that ends when the developer completes construction, or the project comes online (a point to be negotiated). The ground lease would provide the developer the right to terminate the lease for convenience with respect to any part of the property without penalty (except forfeiture of any paid rent) during the due diligence period. Counsel should ensure the lease clearly defines the term of the due diligence period and the owner’s right to terminate if the solar facility is not constructed within a certain period.

The other structure is an option to lease agreement, which provides the developer, in exchange for a monthly fee, with an exclusive option to enter a binding ground lease with the landowner for all or some portion of the property. The ground lease is usually attached as an exhibit to the option to lease agreement. Counsel should carefully review the terms of this ground lease as if it were going to be the actual agreement between the parties because if the option is exercised, it will be. The option agreement will also include the landowner’s promise to cooperate with the developer in applying for permits (i.e., conditional use permits) and will provide the developer a license to enter the property for purposes of testing and site assessment.

Legal description of the property and owner approval rights. Counsel for owners should ensure their clients understand exactly what rights a developer is assuming under the option or lease. Does the landowner have to consent to the location of the lease boundary? Does the developer have the right to demolish existing structures and trees? Are there parts of the property the owner wants to preserve? A developer will want broad rights to determine the location of the project boundary and to demolish anything that will shade its solar arrays. If a landowner wants to exclude specific portions of property from development (e.g., residences, barns, sheds, etc.), counsel should ensure the lease carves out these specific portions of property. Additionally, if the developer has the sole right to choose the boundary for the leased property, there may be some risk that the developer’s boundary will landlock the residue of the owner’s property. Counsel should discuss this risk with the owner, and if necessary, add a provision reserving for the owner the right to cross over the leased property or prohibiting the developer from landlocking the owner’s residual property.

Removal obligations. The lease should require the developer upon termination or expiration of the lease to remove all of the solar facility from above the surface and below the surface down to a certain depth (three feet appears to be common). Because it is unlikely the developer will own the project at the expiration of the term, counsel should ensure the removal obligations are guaranteed by a decommissioning bond.

Decommissioning bonds. A worst-case scenario for a landowner is the developer or its successor goes out of business without complying with the removal obligations set forth in
the lease. To address this risk, the lease should require the developer to obtain, prior to beginning any construction, a decommissioning bond naming the landowner as an obligee and guaranteeing the removal of the solar facility at the termination or expiration of the lease. The bond should be in an amount equal to the estimated cost of decommissioning at the expiration of the lease, without any discount for the salvage value of the equipment, as determined by a licensed professional engineer with experience estimating decommissioning costs. The developer should have no qualms with having to purchase this bond, as the developer will likely be unable to obtain a conditional use permit without one in place.

Separate consideration for due diligence period. A developer’s proposal will provide for reduced rent during the option period or due diligence as compensation for encumbering the landowner’s property during these periods. The developer’s form contract may provide that these reduced payments will be credited towards the first month’s rent if the option is exercised or the project is actually developed. The landowner should push back on this, as those reduced payments are separate consideration for encumbering the property with the option.

Developer’s lender’s rights. A developer will likely need to finance most of the solar projects costs. If so, a developer and its lender will require broad lender protections, including the right of the lender to cure a default by developer or to assign the lease to a third party in the event the developer defaults on its financing obligations. Counsel for the landowner should proposed conditioning any such assignment on the assignee (1) assuming all of the developer’s obligations under the lease including the payment of any past due rent, (2) having adequate experience operating solar facilities, and (3) posting a new decommissioning bond to ensure the facilities are removed at the end of the term.

Mechanic’s liens. The lease should prohibit the developer from allowing any mechanic’s liens being filed against the property, and should require the developer to bond off or otherwise release any such liens within a specific period of time (e.g., within five days of notice).

Easements. If a landowner owns surrounding property, the owner should expect the developer to ask for light easements over this surrounding property to ensure there is never any interference with the solar array. The developer will also need the owner to agree to grant transmission easements to any utility companies. Counsel should carefully review these easements, and confirm that (1) the transmission easements are prepared at the developer’s expense, (2) they are only as broad as necessary, (3) they are coterminous with the term of the lease and (4) the owner has the right to approve the location of the easements.

shipmanJ. Court Shipman,
is an associate in the general commercial group at Gentry Locke Attorneys, where he assists clients with a wide array of legal matters, including commercial transactions, mergers and acquisitions, and business disputes. Before joining Gentry Locke, Shipman was associate counsel at Liberty University, where for three years he assisted the university with various commercial transactions and regulatory compliance matters. He graduated from the Liberty University School of Law in 2012. During law school, Shipman focused his studies on business law and estate planning, and began working as an intern with the university’s general counsel. A graduate of Virginia Tech, Shipman tries to return to Blacksburg at least once a year for a football game. When he’s not practicing law, he is spending time with his wife and two young sons.