Environmental risks persist no matter the asset: considerations for financing renewable power projects, part 2

Many view renewable energy (e.g., solar, wind) as having a low environmental risk profile and are not prepared for the myriad compliance and enforcement risks that may arise from the development of renewable power projects.  While it is true that, once operational, renewable assets typically do not emit air pollutants or discharge wastewater, and so may have significantly fewer compliance obligations than a highly-regulated asset like a petrochemical complex, the construction phase of renewable projects arguably contains just as many risks as one would face for more stringently regulated assets. 

Moreover, lenders often have an extremely low environmental risk tolerance, so an issue that presents the risk of negligible fines or penalties or an immaterial remedial obligation could nevertheless stymie deals critical to the development of renewable energy projects, such as project financings. 

This is the second part of a two-part article that discusses some of the more frequent environmental issues that can arise during renewable power project construction financing transactions.  We encourage you to read Part I of this article, addressing the environmental risks posed by renewable energy projects, lender concerns regarding environmental risks and the impact of COVID-19, and issues that can arise during pre-acquisition due diligence, prior to reading this part.  The following sections address environmental permitting for renewable energy projects, as well as common environmental-related provisions and issues in negotiating EPC contracts and financing agreements.

Permitting Risks

The environmental footprint of a renewables project and its location dictate environmental permitting risks.  With respect to federal permitting, the most likely risks include federal Clean Water Act (CWA) Section 404 permitting for dredge and fill activities in wetlands and the need to consult with and (possibly) obtain permits from the U.S. Fish and Wildlife Service (FWS).  Projects on federal lands or that depend on federal funding or other “major federal action” could also be subject to lengthy National Environmental Policy Act reviews.  

If a renewable energy project cannot avoid wetland impacts, project design may allow developers to minimize impacts so that only a CWA 404 Nationwide Permit (NWP) is necessary.  NWPs are streamlined wetland permits issued by the U.S. Army Corps of Engineers (Corps) that, at most, only require a Preconstruction Notice to the Corps.  Projects that can proceed under an NWP avoid the burdensome public notice and comment process, and lenders and financers may view such permits as lower risk.

The magnitude of state and local permitting burdens depends on the jurisdiction. Northeastern and Pacific coast states tend to have more expansive environmental permitting requirements.  Other states, such as Texas, may have only minimal environmental permitting requirements applicable to renewable projects.

Developers should be prepared to either have key permits in hand when starting the construction financing process or otherwise be able to demonstrate meaningful progress in obtaining such permits.  Otherwise, they risk the imposition of potentially burdensome conditions precedent to funding.  Lenders and investors typically want a defined plan for obtaining necessary environmental permits and completion of any mitigation required under project permits prior to funding. 

EPC Protections

Compliance with permit terms is another key concern of lenders and investors.  While the compliance obligation ultimately rests with the permit holder, the EPC contractor will be the party at the site every day and responsible for constructing the project in accordance with environmental permit terms.  Consequently, developers should vet EPC contractors’ environmental compliance history and require regular reports on environmental conditions and compliance with environmental permit terms at construction sites.

Renewable developers should ensure that their EPC agreement contains robust contractual protections in favor of the developer in the event that the EPC contractor causes a release of pollutants or fails to comply with the terms of applicable environmental permits.  Strong and explicit environmental contractual protections may provide additional comfort to lenders and co-investors that developers will not bear the risk of compliance issues that result from the EPC contractor’s actions.  Developers should also make sure that the EPC agreement tracks any special requirements or conditions imposed in the site lease(s).

Financing Deal Terms

Renewable developers, regardless of whether they are independent or a portfolio company of a well-funded private equity group, should expect lenders to push for aggressive and what would previously be considered off-market positions regarding potential environmental liabilities.  There is little room to negotiate the scope of environmental indemnities in a project financing document, but that does not mean developers should accept unbounded indemnities.  The key is to ensure that the indemnities, however broad, are tied to the project or the project site.  Representations and warranties may be one area where there is more room to negotiate, but renewable developers should expect lenders to push for a low threshold that could result in burdensome disclosure scheduling obligations.   

As noted above, permitting risks are likely to be a focus of lender environmental due diligence.  Requests for permitting opinions from project counsel have ebbed and flowed over the years, but, given the additional comfort they provide lenders and investors with respect to construction risks, renewable developers should be prepared for lenders to insist on such opinions.  Permitting opinions can be time consuming and expensive, adding to transaction costs and potentially causing delays as the parties negotiate the scope of the types of permits covered in the opinion.  Thus, whether a permit opinion will be required and its scope should be addressed as early as possible in the financing process, preferably in the term sheet phase.

Managing permitting risk may also help developers avoid unfavorable environmental-related conditions imposed as precedents to funding or post-closing covenants.  If lenders or investors believe key permits are missing or that a developer is not timely pursuing construction and operating permits or complying with applicable environmental conditions, they may refuse to fully fund a project and only release funds in tranches after certain milestones are met.  Lenders or investors may also push for additional consultation with state or federal agencies to address any perceived deficiencies related to pre-construction site assessments through the inclusion of post-closing environmental covenants in financing documents or purchase agreements.

Conclusion

As the renewables market continues to expand, project developers should prepare for the strict environmental due diligence demands of lenders and co-investors.  If not planned for, these demands can result in added environmental costs, which can disrupt the financial models on which investors rely when making decisions on deals.  Developers should proactively manage the key environmental risks described above, or they may risk exposure to, at best, unfavorable deal terms, or, at worst, delays in closing project financing transactions.  Close coordination with legal counsel and the team of various technical consultants early in the project development process can help mitigate these risks.

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