Commercial division update: Stays of state court securities actions
This column explores recent developments in stay of the state proceedings for defendants facing parallel securities class actions.
The US Department of Energy has adopted mid-course corrections to its loan guarantee program for financing projects that use innovative technologies.
The changes, which become effective Jan. 17, 2017, will address several issues that made the program unnecessarily challenging to navigate.
Meanwhile, the DOE is considering a substantial number of new loan guarantee applications from project developers.
One change is the introduction of “risk-based charges.” This is making prospective loan guarantee applicants nervous, but may prove to be a net positive for program users.
Loan guarantees are meant to help projects that use promising new technologies obtain financing in cases where commercial financing is not available.
The loan guarantee program’s attractions have included not only the availability of financing, but also a very low interest rate. Each loan guaranteed by DOE and funded by the Federal Financing Bank to date has been provided at a spread of 35 basis points above US Treasury bonds of a similar average life. All but one of those loans have been subsidized by Congressional appropriations under the American Recovery and Reinvestment Act of 2009 to cover the credit subsidy cost mandated by the Federal Credit Reform Act of 1990. The credit subsidy cost is the fee that the developer must pay at closing to compensate the government for its exposure from making the loan guarantee.
DOE has some credit subsidy cost appropriation available for current applicants under the existing renewable energy solicitation. However, DOE has told applicants to assume that they will be on their own to pay in full the credit subsidy cost of their loans, subject to a limitation. DOE has promised that credit subsidy charges in the renewable energy project solicitation will not exceed 7 percent of the loan guarantee or, more accurately, any charge above 7 percent will be paid by DOE (up to a total per loan subsidy of US$17 million). The bottom line is the next round of loan guarantees will not be as inexpensive as earlier loan guarantees.
Against this backdrop, some have interpreted the proposed risk-based charges, which will be an additional spread added to the existing Federal Financing Bank spread, as an unwelcome piling on that reduces the attractiveness of the program. That reaction misses an important point.
Under federal law, the credit subsidy cost must be paid in full at financial close and cannot be financed with federal loans. Thus, the credit subsidy cost becomes a substantial additional equity cost, one that could easily increase equity costs by 5 percent to 15 percent. For example, a US$100 million project funded with 60 percent DOE-guaranteed debt and US$40 million of equity that is assigned a credit subsidy rate of 5 percent would require US$3 million to cover the credit subsidy charge. The effect is a 7.5 percent increase in the equity requirement for the project.
The benefit to be weighed against that up-front cost is the discounted interest rate of federally-guaranteed financing over the life of the loan. Adding a risk-based charge to the interest rate makes the debt more expensive. However, the risk-based charge will reduce the credit subsidy cost.
Under the Federal Credit Reform Act, the credit subsidy cost is determined as the projected cost to the government from making or guaranteeing a loan minus the government’s projected receipts. The present value of the future stream of payments of the risk-based charges will count, dollar-for-dollar, to reduce the credit subsidy cost required to be paid at closing. Thus, while federally guaranteed loan proceeds cannot be used to pay credit subsidy cost funds, the requirement to pay additional risk-based charges over time will reduce the amount of the credit subsidy charge required to be paid at closing. Though how the math will sort out in practice remains to be seen, unofficial rumors suggest that there is some hope that the net effect of all this will be to reduce the credit subsidy cost required to be paid at closing to roughly zero.
Previously, a developer could not receive financing under any solicitation for more than one project using the same innovative technology.
DOE had agreed to consider supporting multi-site projects by treating them as a single project in appropriate circumstances. The parts of the project spread over multiple sites had to be “integral components of a unitary plan.”
This standard was applied to approve conditional commitments to two distributed solar projects and a multi-site manufacturing enterprise.
DOE has now simplified the standard by eliminating the reference to DOE discretion and by providing that a qualifying project can be “comprised of installations or facilities employing a single New or Significantly Improved Technology that is deployed pursuant to an integrated and comprehensive business plan.”
Distributed energy projects were possible before, but now their eligibility will be clearer.
Another key change is communication with applicants.
Past applicants will remember that getting straight answers from the DOE staff was not always an easy task. The staff was concerned, or had been instructed by DOE procurement specialists to be concerned, that providing any information to one applicant that was not available to all applicants could give that applicant an unfair advantage. At first, many sensible questions went unanswered. In due course, the program developed a process where questions would, or at least might, be answered by means of responses to “Frequently Asked Questions” published on the program’s website.
Experience has shown that running a financing program targeted at multiple participants developing disparate projects requires a different approach from that involved in a single source procurement. With these changes, DOE will welcome meetings and questions from potential applicants. DOE’s new procedures provide that:
[A] potential Applicant may request a meeting with DOE to discuss its potential Application. At its discretion, DOE may meet with a potential Applicant, either in person or electronically, to discuss its potential Application. DOE may provide a potential Applicant with a preliminary response regarding whether its proposed Application may constitute an Eligible Project. DOE is not permitted to design an Eligible Project for an Applicant, but may respond, in its discretion, in general terms to specific proposals.
The opening of channels of communication between DOE and applicants is real progress from the experience faced by earlier participants in the program.
The responses to questions may not be the last word on issues raised:
DOE’s responses to questions from potential Applicants and DOE’s statements to potential Applicants are pre-decisional and preliminary in nature. Any such responses and statements are subject in their entirety to any final action by DOE with respect to an Application...
Once an application has been filed, DOE is less receptive to client interaction while the application is under review. During this phase, DOE does reach out to applicants to seek clarification on questions that arise during its review.
The prior regulations contemplated a pre-application preceding a formal application, but that approach was used only once, in the program’s first-ever outreach a decade ago.
In practice, DOE has adopted a two-step application process comprising a part I submission followed by a part II submission, if the part I passes muster.
The part I submission allows for initial screening to determine whether a project qualifies under the relevant solicitation as well as its readiness to proceed. The part I submission focuses on “a description of the project or facility, technical information, background information on management, financing strategy, and progress to date of critical path schedules.” The part II submission goes much deeper and is meant to provide the basis for a judgment as to the bankability of the proposed project financing.
To encourage applications, DOE splits the application fee, with payments weighted toward the part II submission, reducing an applicant’s cost commitment until DOE has provided, based on the part I submission, at least some level of preliminary review and encouragement. For instance, under the current renewables solicitation, the part I application fee is US$50,000. The part II fee depends on the amount of financing being sought. For up to US$150 million in financing, the part II application fee is US$100,000. For greater amounts, the part II application fee is US$350,000.
These changes formalize how the program has been operating in practice.
Some quirks in the traditional program have survived. Two surpass the others.
One is that DOE has the right, for any reason (or even without one) to cancel a conditional commitment to issue a loan guarantee at any time prior to execution of the loan guarantee agreement.
This is especially troublesome since, by the time a conditional commitment is issued, applicants will have been required to pay, in addition to the part I and part II application fees, 25 percent of a facility fee. The facility fee is 1 percent of the first US$150 million of loan guarantee sought and 0.6 percent of any additional amount sought. Thus, for example, for a US$200 million DOE-guaranteed loan, the facility fee is US$1.6 million, of which US$400,000 will be payable (and non-refundable) in advance of the conditional commitment.
The application fee and the facility fee are in addition to the substantial costs that an applicant will have incurred when reimbursing DOE for the fees of its legal and technical advisors whose support will be required to achieve that commitment and paying for the applicant’s own advisors. This is an awfully expensive endeavor for DOE to have the legal right to abandon the process for no reason at all.
The consolation is that, in the near-decade since the program has been in effect, conditional commitments have never been rescinded by DOE on a whim. The only cases of cancellation of which we are aware are projects whose prospects of meeting a September 2011 statutory deadline to issue some loan guarantees were dim. The program staff and management fully recognize that the exercise of the ‘nuclear’ option would severely adversely affect the program’s reputation and, to date, they have declined to exercise it.
Another peculiarity of the loan guarantee program is the restriction against applications by a single applicant under a particular solicitation for multiple projects that use the same innovative technology. This is an unfortunate restriction for a program whose mandate includes broadening the use of innovative technologies.
This provision has made developers of distributed generation projects nervous since they necessarily envision multiple projects on multiple sites using substantially identical technology. DOE, which had been both open and anxious to support such projects, found a way forward by treating them as a single project if certain conditions were met. As already discussed, these conditions have been revised and simplified, dispelling any doubt as to the eligibility of distributed energy projects for DOE-guaranteed financing.
Still beyond the permitted scope, however, are cases where a single developer wants to build two similar facilities. To date, DOE has proven cooperative by, at least on one case, treating one facility as “phase 1” of a project and the second facility, to be constructed at a later point in time, as “phase 2.”
The latest changes suggest another possible flexibility, though we are not aware of a precedent for this approach. If there are multiple projects using the same innovative technology all seeking DOE-guaranteed financing, each of which had multiple equity participants, the language suggests that, since not all sponsors need to be included as the applicant, one sponsor could apply as the applicant for one project while a different sponsor could serve as applicant in a separate, but similar, project.
It may be useful to discuss with DOE whether such a work-around might be possible.
According to its website, the Loan Programs Office is currently managing a portfolio of more than US$30 billion in loans, loan guarantees and conditional commitments covering more than 30 projects across the United States.
With the exception of the US$8.3 billion financing in support of the Vogtle nuclear power project, provided in a series of closings over 2014 and 2015, and advanced technology vehicles manufacturing financings, the loan guarantee portfolio consists of renewable energy projects financed under an earlier wave of loan guarantees that had to reach financial close prior to September 30, 2011.
The future prospects for the DOE loan guarantee program remain an open question. Only one “conditional commitment” has been issued for an energy project since September 2011. That was for the storied Cape Wind project off the Massachusetts coast, which, to date, has not closed.
The loan guarantee program still has more than US$40 billion in loan authority available to finance innovative clean energy projects and advanced technology vehicles manufacturing projects.
There are currently three open solicitations for energy projects - one offering up to an aggregate of approximately US$4 billion in financing for renewable energy and energy efficiency projects, another offering up to US$8 billion in financing for advanced fossil energy projects and yet another offering US$12.5 billion for advanced nuclear energy projects. Multiple applications are now proceeding under these open solicitations.
The part I and part II application deadlines under the renewable energy projects and advanced fossil energy projects solicitations have been extended into early 2018. They had been scheduled to expire at the end of November 2016. The deadline for advanced nuclear energy projects solicitations has been extended to mid-2019. The next part I application deadline under each outstanding solicitation is scheduled for January 18, 2017.
The constraint on the volume of the program’s operations is likely to be Congressional support to fund it rather than qualifying projects seeking its support.
These changes to the program should yield an experience for current and future applicants for loan guarantees that will be somewhat smoother than that experienced by earlier applicants.
This column explores recent developments in stay of the state proceedings for defendants facing parallel securities class actions.
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