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United States: Finance model laws clarified

Investor disagreements tackled.

A popular wind project finance structure in the US, known as the flip model, has received important new guidance from the Internal Revenue Service (IRS) that aims to give clarity and minimise disagreements among separate investors who own holdings in the same wind project.

The flip model is a complex partnership agreement that began to see frequent use in the US around 2005. Government wind incentives in America have generally taken the form of tax breaks over the years, which require an owner of a wind plant to have a sizeable tax bill in order to use the incentives.

Mutually beneficial

While many developers do not have the tax bill necessary to use the credits, many outside investors do - so a mutually beneficial co-ownership deal was born, contributing heavily to the US wind industry's growth.

Under typical flip transactions, an initial project developer owns 1% of a project for the first half of the expected 20-year life of the wind plant, while a financial partner owns 99% until it recoups the full value of the 10-year federal production tax credit. An ownership flip then occurs, with the developer taking around 95% stake, and the financial partner owning the balance.

Another transaction usually follows, called a purchase option, with the investor partner selling its remaining stake to exit the deal. But details of the exiting purchase option could not be determined until around the time it was sold, said Internal Revenue Service (IRS) guidance in 2007. Additionally, flips that occurred before ten years required a valuation of equity positions that may not have been foreseen by the two parties. For example, a 5% stake in the project will have a different value in year five when tax credits are still in effect versus year ten when they are not. Many developers and investors entered into the initial flip deals without fully determining the value of post-flipped equity holdings and purchase options.

But recent IRS guidance on the flip structure now allows an exiting purchase option and later equity positions to be set in advance as long as the price is a good-faith estimation of future fair market value.

"If you come up with a reasonable estimate and, particularly if you document it and get independent experts to help you, the fact that you (end up some way off) doesn't necessarily mean that you weren't reasonable," says Greg Jenner, a lawyer with Stoel Rives in Minnesota. "But if you're throwing darts at a wall, that's not going to be something that the IRS considers to be reasonable."

Before the definition, Jenner says the IRS was overrun by questions from wind industry tax and finance professionals wanting better definition of what would be allowed when estimating the future value of eligible projects.

"The IRS started to get overburdened with all these ruling requests," Jenner says. "Conversely, the gunslingers out there would say, 'Well, we have carte blanche to design these deals as aggressively as we want. And then it's up to the IRS to come find us.'"

Although the IRS was very careful to say that its guidance applies only to wind, other renewable energy resources now use it. "If you're doing a flip transaction, everybody follows this model," Jenner says.

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