Renewable Energy and Role of the Decommissioning Security    

All renewable energy developments which operate by way of Lease should consider what happens at the end of the Lease.  In particular, the yielding up obligation on the Tenant and what happens if the Tenant either fails to yield up the property in a suitable state or is in financial difficulty so as not able to yield up the property in accordance with the terms of the Lease.

The Law

Decommissioning Securities are regulated by Contract.  The Lease will include a contractual provision typically known as a Decommissioning Security.

Types of Decommissioning Security

A Decommissioning Security can take different forms.  Those forms could be:

• A cash backed security;
• An insurance backed security; or
• an indemnity insurance backed security.

Each form has both advantages and disadvantages depending on whether you are acting for the Landlord or the Developer.  An analysis of the advantages and disadvantages falls outside the scope of this article but will be published at a later date.

Commercial Considerations

The inception of the Decommissioning Security is a commercial point which needs to be carefully considered by both Landlord and Developer.  If the Landlord is particularly risk adverse, he/she will want Decommissioning Security to be put in place on inception of the Lease.    Whilst this protects the Landlord against potential Tenant defaults, it comes at a cost of the Tenant.  Whether that is cash backed or insurance backed, the cost of the Decommissioning Security comes at the earliest point of the Lease.   It therefore increases overall cost of the project to the Tenant.

How the Development will be funded is a key consideration for both the Landlord and the Tenant.   Whilst the Tenant typically wants to push the funding of the Decommissioning Security to a point later on in the Lease Term, it cannot ignore the Landlord’s concerns.   Similarly, whilst the Landlord would like the inception of the Decommissioning Security from the commencement of the Lease it has to recognise this comes at a cost to the Tenant.  If the project is to be funded by a third party, that third party will want a return on the capital investment.  The greater the return the more appealing the project.  Funders which have a number of projects on offer and will choose the best return before considering projects of a lesser return.  For the Landlord that wants to see the project built and rents received there is a commercial compromise to be had.   The Landlord must balance risk with return.

The Landlord should not ignore the Tenant’s strength of covenant.  A Tenant which has delivered a number of successful projects should have strength of covenant. That should be considered in the overall weighing up of risk verses return.

Yielding Up

The yielding up obligation typically requires the Tenant to return the property to the Landlord in the repair and condition required by the Lease and capable of being used for its historic use.  If the property was previously agricultural then the yielding up obligation should require the Tenant to put the property back into a state where it can be farmed.  It would be sensible for the Landlord and Tenant to agree a schedule of condition prior to entering into the Lease.  This will give both the Landlord and tenant a record of the schedule of condition at the commencement of the Lease.  This is particularly useful bearing in mind that most leases are not for the short term.  It is highly likely that in 40 years neither the Landlord nor Tenant would know of the state or condition of the property at the time of the Lease commenced.  The schedule of condition therefore supports the wording of the Lease in establishing what is a successful yielding up and therefore compliance with the terms of the Lease.

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The Amount

The Both Landlord and Tenant need to agree the amount of the Decommissioning Security.  The amount of the Decommissioning Security should be sufficient to enable the Landlord to step into the shoes of the Tenant and complete the yielding up obligation under the Lease.

The amount of the Decommissioning Security is typically not known and therefore it is subject to valuation.  A valuation would be undertaken prior to the Decommissioning Security being accepted.  That Decommissioning Security should be valued periodically to ensure it is inline with the estimated value to comply with the yielding up obligation.  The method of revaluation could be an index linked review provision.  Alternatively, it could be a market review provision.   This is for the Landlord and Tenant to agree.

Scrappage

Whether scrappage should be included within the calculation of the Decommissioning Security is a point of debate.  The solar energy sector is at a point in time where very few sites have been decommissioned.  There is therefore insufficient data to establish whether scrappage is included within the Decommissioning Security or not.  What values are associated with scrappage is an evolving point which will become clearer as more sites are decommissioned.  Ultimately it will probably come down to first principles of demand and supply.  The market cannot be established for scrappage then scrappage has no value.  If, however, a market can be established for scrappage then we need to determine what that demand is in correlation to supply.  High the demand with no supply will create higher value in scrappage.  Low demand with high supply will have the opposite effect.

By way of example, solar panels may be capable of being recycled if they have damaged panels.  Damaged panels are capable of repair and those panels can then be repowered.  If, however, the panel is not capable of being reused then it is a question of whether the panel can be separated down into components.  The cost of that process will be factored into the scrappage value.  If it is possible to separate out the components of the solar panel in a cost effective manner then there will be an element of value in scrappage.  If, however, the cost of separating out materials results in a break even exercise then scrappage value will be minimal.

If the Developer and Tenant have agreed the scrappage value is included for the purposes of valuing the Decommissioning Security, then scrappage value must be assessed in the same way as the amount of the Decommissioning Security.  This must be subject to valuation at the same time as the value of the Decommissioning Security .  As markets are never static it follows that scrappage values will also not be static.  What could be high levels of scrappage value at one point in time could find themselves eroded if supply outstrips demand.

Tenant Default

The Decommissioning Security should be worded in such a way as to allow the Landlord access to the Decommissioning Security in the event of the Tenant failing to comply with the yielding up obligation.  If the Tenant fails to comply with the yielding up obligation, then the Landlord should be able to step into the Tenant’s shoes and undertake the necessary work.   That work will come at a cost.  The Landlord should be free to withdraw the sums required from the Decommissioning Security to meet that cost.  Whether the Landlord is free to withdraw those sums from the Decommissioning Security without the Tenant’s consent or not is a point of debate.  The Landlord would want to withdraw the sums required to meet the yielding up obligation without recourse to the Tenant  The Tenant would actually want to check that the Landlord was approaching the work in a cost-effective manner.  The Tenant would therefore want to review the invoices prior to sanctioning the release of the Decommissioning Security.

Conclusion

The Decommissioning Security is an essential clause which is often agreed far too quickly.  The prospect of a renewable energy project is an exciting opportunity.  Often the Landlord concentrates too much on the prize of the rent and not the potential long-term cost consequences of Tenant failing to yield up the property.  The Landlord wants to ensure it retains all the rent it earns.  It does not want to use the rent it has earned to reinstate the property because the Tenant defaults.  The Landlord should seek professional advice from its agent and solicitor when drafting Decommissioning Security.

If you would like to discuss your situation, the commercial lawyers at Fraser Dawbarns will be happy to help. Contact Daniel on 0945 461456 or danielball@fraserdawbarns.com for individual advice.

This article aims to supply general information, but it is not intended to constitute advice. Every effort is made to ensure that the law referred to is correct at the date of publication and to avoid any statement which may mislead. However, no duty of care is assumed to any person and no liability is accepted for any omission or inaccuracy. Always seek advice specific to your own circumstances.  Fraser Dawbarns LLP are always happy to provide such advice.