Canada: The Never-Ending Solar Lease

Since the launch of Ontario's Feed-in Tariff (FIT) program in 2009, most property managers in charge of commercial-scale properties located within Ontario have been approached by solar power project developers seeking to acquire rooftop access rights for the development of solar projects under the FIT program.

The typical approach involves a solar company paying rent to the rooftop owner for the exclusive use of the latter's roof for the eventual installation of solar panels if/when a FIT contract is awarded by the Ontario Power Authority (OPA).  Occasionally, substantial sales pressure has been applied in order to encourage rapid action – this is justified by a need to 'lock-up' preferential FIT pricing and/or to get to the head of the queue in respect of electricity grid connection.  Signing bonuses and prepaid rent occasionally form part of the incentive package.   

Property managers who have been approached to sign such contracts will know of the wide range of potential lease counterparties, which include experienced international players, solar panel manufacturers seeking to lock up potential orders in support of built or planned manufacturing capacity, and junior market participants learning by doing on very thin capital in much the same way that their wind industry counterparts did in the previous decade.

Commercial roofs not previously being thought of as prime real estate space, most owners have been only too glad to see any potential revenue at all coming from a traditional cost centre.  As a result, a wide array of suboptimal and nonsensical leasing arrangements have been entered into across the Province.  The most interesting and concerning of these arrangements are what we call the "Never-Ending Leases".  These can take several forms:

The Pure Never-Ending Lease – This situation occurs where the actual commencement date of the lease is made contingent upon the commencement date of the term of a FIT contract – even though the FIT contract pertaining to the property in question has not and may never be awarded by the OPA. Depending on the exact wording of the lease document itself, the Pure Never-Ending Lease may be voided or set aside where, for instance, the FIT program is substantially amended or cancelled or where the OPA is disbanded.  Depending on its exact wording once again, it might arguably also be set aside by a court on the basis that the actual lease commencement date is wholly uncertain.

The Free Undefined Option – Some formulations of the Ontario FIT roof-top lease contemplate a lease term which commences after the exercise of an option to lease (much like a share purchase option).  Unfortunately, we have seen numerous examples in solar roof-top leasing where a single one-time option payment is made to the rooftop owner, but the option period is left unclear, open-ended or, once again, tied to the award of a FIT contract and/or the commencement of construction. This issue largely results from the inherent uncertainty of the Ontario FIT contract award process, local distribution company grid connection and connection cost assessment processes, and the general downward movement of solar project component prices. 

In the case where a one-time option payment is made but no definite option period is specified, the option contract may be void for uncertainty.  In the case where the option period is tied to the award of a FIT contract, one might again argue that changes to the FIT program or the OPA itself might void the option agreement depending, of course, on the exact wording used.

The Roof-Top Lockdown – Because of their broad wording and uncertain terms, some wording formulations used in Ontario's solar market have effectively blocked roof-top owners who have signed solar leases from ever entering the solar market because of a combination of (a) broad wording prohibiting all forms of energy generation development on the roof-top, (b) an uncertain contract term, and (c) the practical inability of the would-be developer to win a FIT contract or otherwise actually develop the proposed project. 

Since solar project development is outside the core competency of most building managers, and because the margins in solar roof-top development are relatively modest, roof managers are unlikely to launch a court battle over any suboptimal lease terms to which have committed to.  As a result, unless and until the developer gains the capacity to develop the project, roof-tops that are locked down in this fashion are likely to remain fallow. 

The Lease Too Short – More a concern of the lessee (the developer) than the lessor (the roof owner), the Lease Too Short is a phenomenon that arose as a result of the uncertainty regarding the award of FIT contracts and grid connection processes.  Developers could never be certain if or when they would receive a FIT contract; therefore they could not be certain when the actual term of the rooftop lease would need to commence. 

As developers have been anxious to postpone the commencement of lease payments until actual energy payments began to flow, some leases technically do not begin until the project is fully built and has attained commercial operation.  This leaves substantial uncertainty between the rooftop owner and the developer (not to mention insurers, mortgagees and other site stakeholders) as to risk, insurance coverage, access rights and, most peculiarly, the ownership of the solar assets on the site during the interim period before the date on which the lease technically starts.

In a similar vein, developers concerned about not paying more than necessary to cover off the 20 year FIT contract term have entered rooftop leases which will technically end prior to the end of the FIT contract with no right of renewal or extension.  This means that the rooftop owner may have a unilateral right to remove the solar equipment from the roof sometime before the end of the FIT contract – thereby reducing the amount of revenue earned by the developer over the course of the contract.

Both of these circumstances obviously leave room for negotiation.

What to Do?

Rooftop owners who have entered into Pure Never-Ending Leases, Free Undefined Options, Roof-Top Lockdown arrangements or Leases too Short, should seek to renegotiate proper lease option agreements with current counterparties.  Where this is not possible, a court order may be necessary to set previously signed lease documentation aside.

Rooftop owners who are contemplating entering into leasing arrangements should:

Carefully Assess Counterparty Capabilities – The solar rooftop development market in Ontario has matured significantly since 2009, such that there are now several credible, experienced and well-financed players serving the space.  Because of the FIT program and the very high likelihood of the continuation of distributed energy procurement programs comparable to the FIT program in the Province, commercial and industrial rooftops must now be seen as having material value.  Building managers should assess potential lessees as they would normal commercial tenants, seeking evidence of financial capacity, background information, proof of insurance, evidence of technical experience and appropriate references.

Seek Monthly/Quarterly Option Payments – Cash flow is critical.  Requiring regular option payments creates the necessary commercial tension to encourage rapid development and to discourage roof-top lockdowns.  A one-time signing bonus is of less value in this regard.  A one-time commencement-of-construction (NTP) payment is worth even less.

Developers that are unable to develop a specific project should have the ability to abandon the project, forfeiting option payments made.  The failure to make option payments on time should result automatically in the termination of the option arrangement (possibly, after a short correction period).

Define Option Terms – Nothing lasts forever.  Rooftop owners should reserve the right to move on to other opportunities or to renegotiate option agreements and lease terms after a set time period (2 to 5 years).  Having an undefined option period creates critical uncertainty with regard to the building which impacts lending and resale value, and restricts future energy development choices.  Setting a clear term on the option period avoids the necessity of obtaining a court order to set aside a faulty contract.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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