Norton Rose Fulbright US LLP
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Right-side, left-side issues are getting more attention in tax
It is common in partnership flip transactions involving solar
and other renewable energy projects on which investment tax credits
will be claimed for the developer to sell the project company to a
tax equity partnership, when the project reaches mechanical
completion, for the appraised value the project is expected to have
at the end of construction.
The partnership uses its purchase price as the starting point
for calculating the investment tax credit and depreciation on the
In many such transactions, the parties have a single loan
agreement for the construction loan, a tax equity bridge loan and
the back-levered term debt to which the construction loan will
convert at the end of construction.
The developer entity that will sell the project company to the
tax equity partnership, and the affiliated developer entity that
will be the “class B member” in the tax equity
partnership, are sometimes co-borrowers of all the debt during the
In addition, the parties sometimes treat all of the assets on
both the right side of the structure — meaning the developer
entity that will sell the project company to the partnership near
the end of construction — and the left side — meaning
the class B member and tax equity partnership — as one big
package of assets that is pledged as collateral to support the
construction and tax equity bridge loans, as if there were not two
separate sides to the structure.
This is not the best approach.
The project company or development company that owns it should
be the borrower of the construction and tax equity bridge debt
without the class B member also being a co-borrower.
The lenders will not want to make a tax equity bridge loan to
the project without a commitment from the tax equity partnership to
buy the project and by the class B member and tax equity investor
to make capital contributions to fund the purchase price.
The tax equity partnership should be a party to an equity
capital contribution agreement, or ECCA, with the class B member
and tax equity investor requiring them to make capital
contributions, provided a series of conditions precedent are
The tax equity partnership should pledge the ECCA as collateral
to secure its obligation under a separate membership interest
purchase agreement, or MIPA, to buy the project company. The seller
can then pledge the security interest in the ECCA in turn to the
lenders. The class B member and tax equity investor should
acknowledge the pledge and the ability of the lenders to enforce
the capital contribution obligations.
When the project company is sold, the tax equity partnership
will have a tax basis for calculating tax benefits equal to the sum
of three things. It will pay part of the purchase price in cash. It
will be treated for tax purposes as assuming the construction and
tax equity bridge debt. It will take the project company with an
obligation to pay the construction contractor the remaining amounts
owed under the construction contract. The cash portion of the
purchase price is the appraised value minus the debt assumed and
the remaining amount that will have to be paid to the construction
If the seller remains liable on the construction and tax equity
bridge loans after the sale, this calls into question whether the
debt was really assumed by the tax equity partnership when the
project company was sold. It is like buying a house that is subject
to a mortgage. If the buyer assumes the mortgage, that is
considered part of its purchase price. If the seller remains liable
on the mortgage, the debt may not have been assumed.
It is helpful if the entity selling the project company is a
real development company. It is helpful if it uses the cash portion
of the purchase price to fund development spending on other
projects that it has under development.
Some tax counsel prefer that the seller agree to cover any cost
overruns on the construction contract above the remaining amount
owed when the project company is sold. This helps to justify any
premium the partnership pays above the bare cost to construct the
Some tax counsel prefer that the partnership pay the full cash
portion of the purchase price when the project company is sold at
mechanical completion using capital contributed by the tax equity
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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