1. business and industrial
2. business operations
3. management
4. project management

o
tio
What is likely to be an industry consolidation and
movement of assets among industry participants will put
a premium on successfully concluding transactions
involving acquisitions and divestitures of power
generation facilities. Careful consideration should be
given to market risk financing, the physical project
facilities, project operations, and project agreements.
Richard L. Burleson
Richard L. Burleson is a Partner
i n the Busi~zessTrmsactio~zssection
of the Houston office of Jaclcson
Walker. H e is Co-Chairman of the
firm's Energy Practice Group. M r .
Burleso~zis a transactional lawyer
with a broad business practice i ~ z
energy tra~zsactio~zs,
i~zcludingoil
and gas, electric power, mergers and
acquisitio~zs,and corporate filza~zce.
H e holds a J.D. from the U~ziversity
o f Houston.
60
A number of factors are currently influencing the rise in
activity of acquisition and divestiture transactions involving
power generation assets in the
United States. In 1996 the Federal
Energy Regulatory Commission
(FERC) issued Order 888, which
required electric utilities to allow
third-party suppliers of electric
power access to their transmission lines.' This action reflected a
movement toward a competitive
li\ 2002, Elsevier Science Inc., 1040-6190/02/$ -see front matter PI1 51040-6190(02)00369-X
power generation industry and
so-called "unbundling" of the
various components of generating, selling, supplying, transmitting, and distributing electricity.
The subsequent issuance of FERC
Order 889 required investor
owned utilities (IOUs) to functionally separate the operation of
their electricity transmission
business from their power generation business and provide
their open access customers
with a broad range of information
about transmission capacity,
pricing, and other information
The E lectricity Jour~zal
to enable them to become more
~ o m ~ e t i t i vIOUs
e . ~ were prohibited from exercising market
power by favoring the transmission capacity requirements of
their own power generation assets
over the needs of competitive
independent power producers
and other generators of electric
power."
hese and other FERC
initiatives throughout the
late 1990s and into the new
millennium were designed to
implement competitive power
markets and have led more than
half the states in the country to
introduce or implement restructuring legislation creating retail
competition in the electric
industry.' Unbundling measures
are viewed by legislators, regulators, and energy policymakers
as essential for creating effective
retail competition. Therefore,
many states, such as Connecticut, Maine, New Hampshire,
and Rhode Island, have required
regulated utilities to divest their
power generation assets, while
other states have merely
encouraged such divestitures as
an inducement to recovering
stranded costs or reducing market power. Some states have
required that utilities engage in a
negotiation and compromise
process through their public
utility commissions as a means
of reducing market power and
developing a competitive marketplace for the retail sale of
electricity. As part of this process, many IOUs have adopted
business plans which contemplate the divestiture of most of
October 2002
their generation assets and a
concentration almost exclusively
on the regulated "wires" business. These types of business
strategies have resulted in a
number of mergers between
utilities which desire to achieve
economies of scale by concentrating on the regulated transmission and distribution
segment of the electric power
industry.' Conversely, other
companies have focused on the
Manv IOUs have
adopied business plans
which contemplate the
divestituve of most of
their
assets
and a-concentvation
almost exclusively on
the vegu Iated "wives"
business.
less regulated power generation
sector and are opportunistically
acquiring power generation
facilities to address the anticipated shortage of power generation in the U.S.
n addition to state and federal
legislative initiatives which
have led to extensive unbundling-related acquisitions and
divestitures, a more recent phenomenon has evolved in the
wake of the demise of Enron.
As financial analysts peeled
away layers of off-balance sheet
financing and complex accounting structures, skepticism within
the financial community has
led other diversified energy
companies with substantial
power generation assets to alter
their aggressive growth strategies."tock
prices of many
diversified energy companies
with significant power generation assets and related debt have
fallen precipitously, regardless
of whether such assets are held in
"Enron-like'' structures7
Faced with the threat of analysts'
rating downgrades, many of
these companies have
announced plans to sell power
generation facilities using the
proceeds to reduce debt and
strengthen their balance sheets8
Moreover, declines in electricity
prices coupled with overcapacity
in some markets has caused a
number of power plant projects
to be postponed or canceled.
In 2001, for example, at least
12 out of 29 announced and
pending projects in Texas were
postponed or canceled. This
represents a reduction of almost
9,000 MW from the 17,000 MW
.~
previously a n n o ~ n c e dAs
the economy improves in Texas
and throughout the country,
opportunistic investors with cash
and strong balance sheets are
participating in auctions and
capitalizing on other divestitures
of power generation assets
brought on by current market
conditions.
The purpose of this article is to
lay out a roadmap of issues, ideas,
deal structure, and practice considerations which parties may use
as a resource in successfully
managing power generation
acquisitions and divestitures. The
article begins with an analysis of
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the principal components of every
power project and a discussion of
the factors within each component which are likely to become
deal points in the purchase and
sale agreement. Next is a section
on letters of intent involving
power assets and issues which
need to be addressed. A section
on due diligence lists the primary
areas of focus regarding the
assets, document review, and
legal analysis required to effectively go forward into the documentation phase. The final section
discusses in detail the purchase
and sale agreement and the legal
and commercial issues which are
likely to require attention by the
parties.
11. Principal
Components of Power
Projects
Although every power project
has characteristics that are
unique, it may also be said that all
projects share many of the same
principal components. Issues
arising from one or more of these
fundamental components will
likely be the focus of the initial
deal structure outlined in the letter of intent, the investigations
emphasized in due diligence, and
the drafting considerations of the
purchase and sale agreement. The
basic components which are present in every power deal are
project sales and market risk; the
project parties; the project facilities; operations and personnel;
the project agreements; and
financing1'
62
A. Project sales and market
risk
Project sales will generally be
based upon either a long-term
purchase agreement or alternatively upon the current market
demand for plant output. Many
newer merchant plants have
committed a portion of their offtake under long-term agreements
with the balance sold at fluctuating market rates. Portions of the
The value of a
long-term power
purchase agreement
depends on such
factors as the
physical operational
capability of the plant
to produce power
efficiently.
uncommitted future power production may be subject to hedges
which limit downside exposure or
cap the upside market opportunity. The value of a long-term
power purclmse agreement
depends on many factors including the physical operational capability of the plant to produce
power efficiently. Other factors
such as fuel cost, force ~nnjeure
events, and creditworthiness of
offtakers can significantly affect
the economics, commercial viability, and value of a plant. Market
demand itself will significantly
affect the viability of merchant
plants. Simply put, the value of a
power project is derived from the
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past, present, and future cash
flow performance and from the
projections based on historical
performance. Factors which
assure steady income streams
and mitigate market risk contribute to the value of a project.
Successful merchant projects are
typically low-cost producers
which have project structures
enabling them to maximize revenues and adjust to market conditions. For example, merchant
plants often have in place tolling
agreements for delivery of excess
capacity or fuel supply agreements which link the price of the
fuel to the market price of power.
In some cases, the fuel supplier
may have agreed to subordinate
its right to payment in favor of a
project lender.''
B. Project parties
1. The sponsor. There are
numerous parties to an operating
power project, each of which has a
distinct role. Analysis of the
project parties begins with the
project owner or sponsor. Most
power projects are projectfinanced and therefore the
physical assets will likely be held
in a special-purpose entity (SPE)
separate and apart from the
balance sheet of the sponsor.
Nevertheless, the organizational,
operational, and financial
viability of the sponsor will be
critical elements in analyzing the
power project. In some cases the
project may be owned by a
partnership or joint venture
among industry participants. In
The Electricity Journal
this instance, the organizational
structure of the venture and level
of support provided by its
members will require critical
analysis.
2. The fuel supplier. After the
sponsor itself, the project fuel
supplier is likely the most
significant party to the overall
project structure. Fuel constitutes
between 60 percent and 80
percent of the project operating
cost and will most often
determine the level of
competitiveness of a project.
Analysis of the fuel supplier may
begin with whether any conflicts
of interest are present in the
supplier's existing commitments.
The supplier's experience in the
region where the facilities are
located and the size and type of
project will also be important.
However, the most critical factor
in evaluating the fuel supplier is
credit. The reliability of the fuel
supplier to stand behind its
obligations to make physical
deliveries is essential to a
successful project.12
3. The operator. The project
operator plays a vital role in
determining the viability and
profitability of the facilities.
Although the operator itself is not
necessarily responsible for
equipment obsolescence and
mechanical failures, the
demonstrated ability of the
operator to get the plant back on
line after interruption is of critical
concern. The operator's
effectiveness in managing
expenses and scheduled
October 2002
maintenance will be reflected in
its track record and will often
determine the success and value
of the project. The incentive
structure of the operations and
maintenance agreements often
influence the effectiveness of the
operator.13
4 . The offtaker. Project offtake
is the basis for the project's
revenue stream. A successful
project must either have a long-
A successful pvoject
m u s t either have a
long-tevm purchase
agveernent with one
ov move cveditwovthy
puvchasevs ov stvong
market demand fov
the output at a n
acceptable price.
term purchase agreement with
one or more creditworthy
purchasers or strong market
demand for the output at an
acceptable price. As discussed
above, some newer projects rely
on a combination of these models
for generating a cash-flow stream.
Counterparties to project offtake
agreements often contribute to
minimizing market exposure by
making guaranteed capacity
payments or variable production
payments which match variable
production costs. Mitigation of
market risk may also be
accomplished through contracts
with offtakers which pass through
cost increases due to general
inflation, fuel price, or other cost
increases beyond the control of
the project sponsor.'"
C. Project facilities
Analysis of the physical project
facilities should begin with a
review of the turbines, including
an analysis of the manufacturer,
the fuel source, peak capacity,
heat rate, the commercial operation commencement date, and the
terms and provisions of the turbine purchase and sale agreement
and related warranties. The
operating conditions, type of fuel,
and mode of operation such as
base load or cycling, directly
affect the reliability of the plant. A
merchant power plant which
anticipates selling power into a
competitive power market without the benefit of long-term contracts should be using technology
that ensures high reliability, high
productivity, and low operating
costs. The real estate on which the
plant is situated must also be
considered, much in the way of
any other real estate transaction.
Proximity and access to natural
gas pipelines, fuel storage facilities, and grid interconnection is
a significant factor. Easements
and rights-of-way necessary to
operate and maintain the facilities, including fuel and work
storage areas, are an essential
part of the physical assets. Water
rights are also of critical concern
and access to wells, lakes, rivers,
and wastewater sites is imperative. Land use regulations and
required permits must also be
reviewed.'"
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63
D. Project operations
The historic operating data for
a project provides a benchmark
against which to assess forecasts
and pro forma projections. The
technical parameters for evaluating an operating project
include the heat rate, load factor,
major maintenance cycle time,
cooling water availability, and
emissions compliances. Operational analysis should also
include a review of the operator's expertise and experience,
as well as its planning, budgeting, and staffing records
and projections. A proactive
operator will have established
specific procedures for operation, maintenance, predictive
and preventive maintenance,
performance monitoring, plant
chemistry control, and environmental monitoring. Operating
plans should also include
safety and emergency planning
provisions. Training programs
for staff and plant personnel
assure continuity in developing
operational and maintenance
expertise.16
E. Project agreements
The project agreements represent an integrated network of
complex contractual obligations
with linked pricing which
together generate a determinable
operating cash flow. The documents should reflect a reasonable
allocation of risk among the
project parties best able to bear it.
Project risk analysis should
include the identification of areas
where parties assume or incur
inappropriate levels of risk.
Negotiations should center on
reallocating such imbalances in
the project structure. The project
documents which are likely to
survive the sale or change of
control of a power generation
facility include the operations
and maintenance agreement, the
fuel supply agreement and the
offtake agreement for the sale of
power, steam, or other product
output. The surviving documents and the newly created
project documents should be
carefully aligned to avoid contractual ambiguity. For example,
the terms and provisions of the
fuel supply and the offtake contracts should be carefully coordinated. Provisions regarding
choice of law, jurisdiction,
arbitration, default, and force
majeure should be consistent
among all the new and old
project documents.17
F. Financing
Most power facilities are subject to project financing structures
whereby the lender has sole or
primary recourse to the project. A
purchaser may seek to acquire the
project subject to the existing
credit facility or alternatively to
replace it with new financing. In
the case of new financing, the
lender will evaluate the project
based upon its cash flow and
revenues. The lender will then
make a determination whether
the project earnings are sufficient
to service the debt. The project's
sensitivity to potentially adverse
conditions will significantly
impact the economic feasibility
and ability to finance the project.
In other words, a non-recourse
lender must feel comfortable that
the loan can be repaid on a worstcase basis. Alternatively, direct or
indirect guarantees of third parties may be required. To the
extent such credit enhancements
are in place for an existing credit
facility, they must either be
replaced or assigned. Likewise,
the ierms and conditions for
replacing or preserving such
credit enhancements must be
established at the time the
facilities cl~angecontrol.18
f a project is to be acquired
subject to an existing credit
facility, the purchaser must be
assured of the current state of
compliance with the terms
and provisions of the project
financing. Even if a new credit
facility is to be established, the
purchaser will be required to
make representations and warranties about the facilities to the
lender. Therefore, a purchaser
must learn as much as possible
about the project during the
-
64
(-
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-
negotiation and due diligence
phases.
When the parties have reached
a stage in their discussions that it
appears a deal has been struck
and both sides desire to proceed
with negotiating a purchase and
sale agreement in connection with
the facilities, it is often helpful to
set fort11 the basic understanding
of the parties in a letter of intent.
In the years following the wellknown decision of Texnco, bzc. u.
Pen~zzoilco.,19 there was much
discussion concerning "letters of
intent" or similarly named documents as a means of facilitating
transactions. The only true consensus reached among commentators is that the use of such a
document may or may not be
de~irable.~'
However, careful
drafting of proposed terms and
conditions and inclusion of
express provisions regarding
confidentiality and exclusivity are
likely to assist the parties toward
smoother negotiations and ultimate closing. Due to the complexity of the contractual scheme
and the operations and maintenance requirements of power
facilities, the acquisition of the
facility is not unlike acquiring an
operating business. Although the
transaction may be structured as
an asset purchase agreement, the
agreement must contemplate the
transfer of a dynamic going concern. A well-drafted letter of
intent is an essential tool for
establishing momentum and
October 2002
identifying key provisions to a
proposed purchase and sale
agreement. The letter of intent
facilitates the transaction and
demoi~stratesthe sincerity and
good faith of the parties. The following is a general overview of
the structure and provisions
which are con~monlyincluded in
a letter of intent involving a
wower generation facility.
A. Scope
The letter of intent is an
agreement, entered into by the
parties to an acquisition that
memorializes the parties' commitment to the completion of the
transaction and sets forth the
general outline for going forward.21It should specify issues
already agreed to and point out
areas where further negotiation
will be needed.22Reference
should be made to a proposed
purchase and sale agreement
contemplated by the parties and
the basic terms and provisions
which are to be included in the
agreement. The identities of the
buyer and seller should be specified if known and provision
(
should be made for permitted
assignments of the agreement. A
general description of the facilities should be included along
with a reference to the principal
project documents which are to
be assigned to the purchaser. At
a minimum, the description of
the project documents to be
assigned should include the offtake contract, the fuel supply
contract, the operation and
maintenance agreements, and
the warranties under the engineering and construction agreements. The parties should also
describe the primary physical
assets that are to be excluded in
the transaction. The purchase
price should be specified, along
wit11 any anticipated purchase
price adjustments and the general procedure to be used for
malting purchase price adjustments. Reference should be
made to the requirement for
including usual and customary
representations and warranties
and specific reference should be
made to any representations and
warranties which are unusual or
which one of the parties knows
will be difficult or controversial.
Similarly, the parties should
refer in the letter of intent to the
inclusion of usual and customary
conditions of closing, including
any assignment and assumption
of the project financing facility
which may be contemplated.
Reference to conditions such
as project agreement counterparty consents or governmental
approvals which the parties
expect to become controversial
during the course of negotiations
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55
should also be made. Other
special requirements or understandings of the parties to be
included in the proposed purchase and sale agreement should
be referenced in the letter of
intent. For example, if parties
anticipate certain remedies for
non-performance, or require
indemnifications from third
parties, those requirements
should be generally detailed in
the letter of intent. The letter of
intent should also resolve issues
regarding dispute resolution and
choice of law.
he purpose of this portion of
the letter of intent is neither
to bind the parties to the specified
provisions nor draft the provisions which will be in the agreement, but rather to narrow the
scope of issues to be negotiated
by the parties in the purchase and
sale agreement. To the extent that
the parties can address the primary legal and commercial
issues in a general way in the
letter of intent, the process of
negotiating a purchase and sale
agreement will be substantially
facilitated. Ideally, the parties
would then only have to negotiate issues raised by the findings
made during the course of due
diligence.
Non-binding provisions
The letter of intent will have
binding and non-binding provisions. The binding nature of a
letter of intent normally depends
upon the parties' intent to be
b ~ u n d . 'Therefore,
~
the letter
must clearly express which
66
provisions are intended to be
binding and which are not, so as
to prevent the entire agreement
from becoming binding on the
parties.24 ~11eparties can normally avoid being bound by a
provision by merely labeling it as
"non-binding."'" As additional
precaution against unintentionally making certain provisions
binding, it is advisable to state in
the letter of intent that, should
the parties fail to consummate
the transaction, the non-binding
provisions will not form the basis
of liability as to any party to the
agreement. Additionally, the
parties should take care to draft
non-binding provisions using
conditional language rather than
positive wording. References to
the terms of the purchase and
sale agreement should be nonbinding and the text discussing
these provisions should be
drafted as prospective and
l~~~otl~etical.~~
inding provisions
Certain binding provisions are
typically desired and the parties
~
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should expressly state which
provisions are to have binding
effect. Letters of intent often
provide that each party is bound
to refrain from making public
disclosures concerning the particulars of the transaction. These
provisions often include protection against disclosure of the
transaction and promises by each
party not to solicit the employees
of the other.27Pricing under fuel
supply agreements and power
purchase agreements is often
highly confidential and the parties must have a 11igl1 level of
trust and assurance that these
provisions will not become public or used competitively if the
transaction is not consummated.
"Lock-up" provisions require
the seller to compensate the
buyer in the event the transaction
.'~
is not ~ o r n ~ l e t e dUndertaking
the due diligence necessary to
make an informed acquisition
decision on a power facility is
expensive and time consuming.
Such provisions have binding
effect and are designed to prevent the seller from withdrawing
from the transaction in response
to a more favorable offer by a
third party.29Similarly, "no
shop" or exclusivity provisions
are also aimed at the protection
of the buyer by preventing the
seller from soliciting or accepting
any offers from third-party bidders for a set period.30 During
this period, only the parties to the
letter of intent may negotiate.
The letter of intent may also
include binding agreements by
the parties regarding the allocation of the costs and expenses of
The Electricity Jourml
negotiation should they fail to
complete the transaction. Usually
the parties will agree to bear their
own costs.
he letter may also expressly
impose a duty upon the
parties to continue to negotiate in
good faith after the execution of
the letter of intent. This may or
may not be a binding obligation
regardless of any expressed
intention of the parties depending on the relevant state's law.31
Finally, each binding provision
must be supported by consideration, the granting of which
should be recited in the letter
of intent.32
letter of intent may prove useful.
The first and most common is at
the preliminary stage of the
transaction following a cursory
agreement between the parties on
the most basic of terms." This
enables the buyer to commit
resources to conducting the due
diligence. The second may occur
later in the process, primarily
when one party becomes wary of
D. Signatories of the
letter of intent
A letter of intent must be
signed by each party intended to
be bound. Should a particular
state's statute of frauds call for a
letter of intent to be in writing, it
is generally required that for the
writing to be sufficient it must be
signed by the person against
whom enforcement is
Since each party will most likely
desire to be able to enforce the
agreement against all other parties, each party must sign the
letter of intent. Since many
power projects are owned by
special-purpose entities, it is
advisable to have both the project
sponsor and the SPE sign the
letter of intent.
E. Timing
There are two main points in a
transaction when execution of a
October 2002
the other's willingness to consummate the t r a n ~ a c t i o n . ~ ~
F. Earnest money
If one party is apprehensive
about the other's resolve to complete the transaction, the concerned party should insist on a
substantial non-refundable
deposit as a condition to proceeding. Such provisions are
advisable because the violation
of a letter of intent at an early
stage of the transaction may
produce insufficient damages or
damages of such a speculative
nature that litigation to recover
them is not cost-effe~tive.~~
The
final agreement should reduce
the purchase price by the
amount of the deposit. Furthermore, the letter should generally
provide for a refund of the deposit
should the seller withdraw from
the transaction in violation of the
agreement.37
Due diligence is probably the
most important-and also the
most rigorous and expensiveaspect of any acquisition process.
It is also the process that determines which deals will be successful and which will not. For
these reasons, many sellers of
power assets will themselves
conduct some level of due diligence on the assets to be sold
prior to opening a data room to
potential buyers. The advantage
to this proactive approach is that
if an issue is discovered, it will
likely cost a seller substantially
less to fix the problem than a
buyer would demand as a credit
against the purchase price.
Even if the problem cannot be
immediately resolved, the seller
will be able to disclose it in
advance and minimize the
adverse effect of having to
deal with issues discovered by
the potential buyer. A seller is
likely to experience a much
smoother transaction with a
higher likelihood of closing if it
knows in advance where potential problems lie. In addition, the
seller will be able to better
anticipate what the buyer will
discover in the course of its own
due diligence.
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A. Asset components
Power generation assets are
composed of numerous components. Aside from the physical
assets themselves, which must be
tested and evaluated by engineers
and technology specialists, the
contractual scheme of the project
will be the subject of careful
review by counsel to the buyer.
Tlze documentation evidencing
the obligations of the project
parties must be reviewed to
assure that all legal impediments
existing in connection with the
contractual framework of the
project are addressed by the parties in the course of negotiating
the transaction. Some of the more
significant documents which
must be reviewed include the fuel
supply agreement, the power
purchase agreement, the turbine
purchase and sale agreement,
related warranties and maintenance agreements, the engineering, procurement, and
construction agreements (including related maintenance agreement and warranty), the project
financing documents, intellectual
property and license agreements,
transmission interconnection
agreements, title reports and land
use restrictions, and UCC lien
filings.
his analysis requires a
determination of the term or
duration of the project documents
and a careful analysis of the legal
obligations of the parties. In general, due diligence should confirm
that the terms and provisions of
the project documents and the
obligations of the parties are
68
(
coordinated and provide for an
acceptable level of turnkey
operation of the project for a
specified term.
1. Fuel Supply Agreement.
The Fuel Supply Agreement
will typically be a long-term
agreement with a duration
extending at least for the term
of the project's senior credit
facility. If there is a long-term
power purchase agreement
associated with the project, many
of the terms of the Fuel Supply
Agreement should be compatible
and coordinated with the terms
and provisions of the offtake
agreement. The principal areas
for review in the Fuel Supply
Agreement are areas concerned
with quantity, delivery schedule,
price, and quality. The quantities
to be purchased should be
sufficient to meet the maximum
obligations under the offtake
agreement; however, they should
retain flexibility to address
variations due to dispatch and
seasonal adjustments. Analysis of
the delivery schedule should
include a review of the
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nomination procedures and
permit flexibility to vary the
quantity to be delivered and the
schedule for delivery. Storage
capabilities should also be
reviewed. The agreement should
be specific about the delivery
point and whether the supplier
has the right to change delivery
points. Pricing should also be
consistent with the revenue
stream under the power purchase
agreement including price
adjustments and pass-through
pricing. The price of fuel will
either be fixed, based on an index,
or established by regulation.
Fixed-price contracts may also
periodically be adjusted based on
an index. Index pricing may be
based on the source of origin or
the point of delivery. The buyer
could be exposed to unwanted
price risk if the offtake is not tied
to a similar price or index. Pricing
I
may consist of two types of
charges, one which includes a
demand charge and one which is '
based solely on the commodity
itself. The demand charge
component is designed to assure
a firm delivery obligation of the
seller and requires payment by
the buyer even if the gas itself is
not purchased. The commodity
charge is based only on the
quantities actually purchased.
The contract may have take-orpay provisions which could
present problems for the buyer.
Such provisions may be mitigated
by make-up opportunities or
clauses granting the right to
resell. The quality of the gas
should conform to the project
~
The Elect~icituTour~zlzl
contract should address the
right of the buyer to accept
non-conforming fuel, as well
as the right to reject it.
upplier credit is another
issue to consider. Contract
provisions may address credit
concerns in a number of ways.
The seller may provide corporate
guaranties or letters of credit to
assure performance. Alternatively, the seller may grant a lien
on dedicated reserves or dedicate
certain reserves to supply obligations under the contract. Other
provisions of the Fuel Supply
Agreement which should be
coordinated with the power purchase agreement include force
lnajeure and default. Force majeure
provisions should require the
seller to curtail other interruptible
obligations first and curtail firm
obligations ratably across all
purchases. Demand charges
should be excused during force
majeure and the buyer should be
permitted to terminate the
agreement after a specified period
of time. The contract should contain bilateral cover provisions in
the event of default and compensation for the buyer for actual
losses if cover cannot be obtained.
Finally, transportation agreements must be coordinated with
the Fuel Supply Agreement.
Some contracts may combine
these obligations and provide
for the sale of the fuel on a
"delivered" basis which reflects
the cost of transportation. Natural
gas transportation agreements
should assure an adequate noninterruptible pipeline capacity
sufficient to fulfill the terms of
October 2002
the Fuel Supply Agreement.
These agreements should also
provide for an interconnection to
transmission and distribution
systems required in order to fulfill
the seller's obligation under the
Fuel Supply Agreement. A buyer
should carefully review the
transportation costs and the
factors which are built into the
pricing s t r u ~ t u r e . ~ ~
2. Power Purchase Agreement.
Many of the plants developed by
independent power producers in
the late-1980s through the mid1990s committed most, if not all,
of their energy production under
long-term Power Purchase
Agreements. Later, the market
evolved for the development of
merchant plants whereby plant
owners sell a portion of their
power at market prices and enter
into tolling agreements with
natural gas suppliers which pay
tolling fees and make the
decision whether to generate
electricity or not." More
recently, projects have evolved
which commit a portion of the
power production under longterm contracts and reserve a
portion for sale at market prices.
A review of the Power Purchase
Agreement will involve much of
the same type of review as is
required on the Fuel Supply
Agreement. Provisions
regarding assignability, credit,
price, force ~mzjeure,events of
default, and indemnity must be
carefully reviewed. The
purchaser's creditworthiness is
critical. Understanding the
buyer's and seller's rights and
obligations is essential for
effective risk assessment. If the
facility is a "qualifying facility"
under the Public Utilities
Regulatory Policies Act of 1978
(PURPA), an assessment may
be necessary to determine
whether the utility purchasing
the power offtake is doing so
only because it is compelled
under applicable federal law or
whether it actually needs the
power. This analysis will aid in
understanding the relative terms
and provisions of the agreement.
As previously discussed, the
terms and provisions of the
Power Purchase Agreement
should conform to comparable
provisions of the other project
documents.
nalysis of the Power Purchase Agreement should
focus on the term, quantity, obligation to purchase, pricing, and
financial obligations. These are
the principal provisions which
affect the revenue stream. If
the facilities are subject to a
project financing which is to be
assumed by the buyer, the term of
the agreement should equal or
exceed the term of the financing.
2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 52040-6190(02)00369-X
69
The analysis should focus on the
provisions or events that could
reduce the term of the agreement.
If the facilities are not projectfinanced, the term of the agreement may have less significance.
In either event, the quantity of
power to be supplied under the
agreement, and the delivery
obligations of the seller, should
also be clearly understood by the
buyer. In addition, the agreement
should specify the rights of the
parties to power produced above
the contract quantity. The rate and
price payable under the contract
may also require careful analysis.
If the energy purchaser is paying a
bundled rate, it will be important
to separate the energy cost from
the capacity charges. Capacity is
the ability to generate electricity
and reserve it on behalf of a customer. The energy itself is the
flow of elections. A bundled rate
does not distinguish between
energy and capacity. In addition,
charges for ancillary services are
priced separately, usually at a
market-based rate. Separation of
the respective charges allows for a
clearer understanding of anticipated revenues. A purchaser
should focus on events which,
under the terms of the agreement,
could bring about pricing changes
and affect revenue stream. For
example, price cliffs such as regulatory actions which result in
sudden changes in pricing must
be considered. Such changes are
often present in connection with
projects involving renewable
energy. A provision requiring
the seller to maintain its status
as a qualifying facility should
be considered because failure to
maintain suc1-1status could trigger
a new pricing structure or open
the door to negotiations for new
and likely lower pricing. Other
provisions of the agreement
which the purchaser should
scrutinize are curtailment and
dispatch rights. If the purchaser
of the power has the right to
reduce quantities required to
be purchased or dictate the times
that power is to be delivered, the
plant owner should be sufficiently compensated for these
variables. Curtailment could
have ramifications beyond revenue loss. Changes in production can damage equipment
and significant curtailments
could trigger certain FERC
regulations regarding operation
and maintenance requirements
that could cause a project to lose
its qualifying facility status.
Other provisions which should
be reviewed are any buy-out,
buy-down, or postponement
options which enable the purchaser of the power to alter its
offtake obligations under the
agreement. Finally, the buyer
should carefully review provisions which deal with assignment rights and the conditions
under which assignments may
be made.''
3. Operations and
aintenance Agreement. Like the
other project agreements, the
Operations and Maintenance
(O&M) Agreement must be
coordinated with and contain
terms and provisions which
substantially match those of the
other project documents. A buyer
should review the agreement with
a view to understanding the
discretion the operator has to
effect change with respect to the
project's business and revenue
projections. As previously
discussed, operator experience
and expertise are important
variables in evaluating the
operations of the plant. However,
the terms of the O&M Agreement
itself can have a significant impact
on the effectiveness of the
operator in managing plant
operations. Compensation is
generally based on either a fixed
price with incentive provisions, a
cost-plus basis, or a cost-plus
basis with bonus/penalty
provisions.i' A fixed-price
contract may reward the operator
with incentive payments for
keeping operation and
maintenance expenses below a
specified amount or contain an
escalating fee based on an agreed
index. Since most costs are
variable over the life of the
project, the incentive provisions
should be carefully reviewed to
gain an understanding of the
--
70
C 2002, Elsevier Science Inc., 1040-6190/02/$ -see front matter PI1 S1040-6190(02)00369-X
Tlze Electricity Joz~srznl
operator's historical performance
and the anticipated expenses
which have either already been
incurred or those which are yet to
be incurred. A cost-plus contract
compensates the operator for
actual costs plus an overhead
factor and a fixed fee. These types
of agreements may permit the
owner to avoid paying a large
contingency risk premium yet do
not motivate the operator to
perform efficiently. A cost-plus
provision with a bonus/penalty
premium may accomplish the
combined objective of avoiding a
contingency risk premium and
provide incentive the operator to
perform efficiently.
he O&M Agreement should
have provisions requiring
the operator to periodically
establish budget estimates for
plant maintenance and planned
overhauls. These provisions
should be compared to actual
deliveries by the o
period of time and an a
performance compared
geted estimates. There should
also be an analysis of w
of operation the operat
mitted to pass through to the
owner.
The O&M Agreemen
include express provis
nants, and remedies re
operator to operate th
manner consistent with the
requirements of all of
documents and to avo
any equipment warranties.
Another important is
sider is the extent of
which an operator w
for breach of the c
damages are often limited to the
fees earned in a given year. Unlike
the counterparty credit risk associated with other project documents, credit support is not
typically relied on as heavily for
O&M Agreement performance
assurance. Instead, parties tend to
rely on the operator's track record
and the incentive structure of the
O&M Agreement.
rovisions regarding assignment and change of control
ranties and licenses for technol-
4. Engineering, Procurement
aud Construction Agreement. A
review of the Engineering,
Procurement and Construction
(EPC) Agreement should focus on
the warranty and the duties of the
EPC contractor to service and
maintain the facility. The
circumstances under which the
contractor is required to repair or
maintain the facility and the
enforceability and duration of the
contractor's obligations are
important issues for the buyer to
consider. Any exceptions to the
contractor's responsibilities
should be carefully examined.
Again, assessing the
creditworthiness and
determining the ability of the
contractor to perform are vital to
the due diligence process.
5 . Project finance documents.
If the project is financed with
recourse solely to the project and
the buyer intends to acquire the
facilities subject to the existing
financing, the terms of the
Financing Documents will be very
significant. First, the assignability
of the project and the financing
package must be assured. The
buyer will want an in-depth
understanding of the terms and
pricing of the financing
arrangement. Important issues
will include early payment
penalties, ongoing covenant
obligations of the owner such as
financial reporting of project
information, and conditions
precedent to transfers of
ownership. Continued
effectiveness and enforceability of
other key project documents such
-
October 2002
(_
2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X
71
as the Fuel Supply Agreement
and any Power Purchase
Agreements will be essential to
avoid triggering default
provisions in either of those
agreements or in the Financing
Documents. One of the primary
objectives of the Financing
Documents is to prevent project
management from changing the
risk profile of the project.
Accordingly, the loan documents
may limit the owner's discretion
in the scope and operation of the
project. For example, the loan
agreement will likely restrict or
limit the right of the project owner
to incur additional debt. As a
result, the purchaser would be
required to fund capital
expenditures with owner equity.
The loan documents might also
preclude or restrict a project
owner from distributing residual
cash. There may also be debt
service reserve requirements.
Such requirements often require
approximately six month's debt
service to be held in escrow. The
financial covenants of the credit
facility should be compared to the
historical ability of the project to
maintain the required ratios. The
buyer should review the grace
periods relating to defaults, as
well as provisions restricting
inter-company loans. The buyer
should also review the collateral
arrangements under the financing
documents to assure against any
unduly burdensome collateral
requirements or covenants with
which it is unable to comply.
Many newer project or structured
financings have taken on a hybrid
status which draws upon limited
72
sponsor recourse and third-party
credit enhancement. The
agreements, which together form
and support the credit facility to
be transferred to and assumed by
the buyer, must be carefully
reviewed as part of the due
diligence process:'"
6. Intellectual Puope~ty
and License Agreements. Many
project owners have either
developed or acquired
technology which is proprietary
to the project and which is
essential to continued operations.
Such technology may include
software which increases fuel
efficiency or load predictability.
The terms of assignability of
this teclmology must be
examined to ensure the
continued economic viability of
plant economics. If the seller has
developed and patented the
technology, it will be necessary to
obtain a license prior to
completing the acquisition. If the
technology is licensed from a
third party, that party's consent
to the transfer will likely be
required.
c 2002, Elsevier Sc~enceInc ,1040-6190/02/$-see front matter PIT S10J-0-6190(02)00369-X
7. Land Use, Title
Examinatiorzs, Permits and
Eueviuonmental. The sale of a
power generation facility will
involve a substantial transfer of
real and personal property assets.
It will be important early in the
due diligence process to review
the existing title insurance
covering the project and to secure
a commitment for the title
insurance covering the project
real estate and immovable
fixtures thereon." Substantial
savings will be available to the
extent the turbines and other
component parts of the plant are
classified as personal property
rather than as fixtures on the
premises. This will result in lower
title insurance premiums being
incurred by the seller upon the
transfer of the facility. Surveys
and physical inspection of the
property should be conducted. A
buyer should also review the
representations and warranties
made by predecessors in title. In
addition, land use regulations
should be reviewed. A
determination should be made of
all permits required to operate the
facility. The permits which have
been obtained by the current
owner should be reviewed to
determine the terms and the
ability to transfer and assign such
permits. These permits include
operating permits for air
emissions, wastewater, storage
tanks, and construction permits.
nvironmental issues will be
of paramount concern to the
buyer and the seller. Appropriate
levels of environmental assessment should be conducted to
determine pre-existing conditions
of air, soil, ground water, structures on the property, endangered
species, or historical or archeological sites. Environmental consultants and local counsel may be
used extensively in this regard
since the parties will address
many of these issues in the
environmental indemnity provision of the purchase and sale
agreement. Similarly, UCC
searches should be ordered and
studied as soon as possible in the
due diligence process.4"
The acquisition of power generation assets requires a thorough
analysis of federal law issues. The
nature of the assets being
acquired and the existing business model of the buyer will significantly impact the level of
regulatory jurisdiction which may
be applicable to the transaction.
The following background
regarding the federal statutory
scheme is an introduction to the
issues to be considered in connection with due diligence during
the purchase and sale of most
power generation facilities.
I . PUHGA. The primary
regulatory consideration in a
utility restructuring transaction,
including the sale of a power
generation facility, is the Public
Utility Holding Company Act of
1935 (PUHCA). A "holding
company" under PUHCA is
generally defined as a company,
not otherwise exempt, which
either owns, controls, or holds the
October 2002
power to vote, 10 percent or more
of the securities of another
company that owns or operates
facilities used for a generation,
transmission, or distribution of
electric energy for sale. Moreover,
any company which owns and
operates power generation
facilities is defined under PUHCA
to be an "electric utility," unless
otherwise exempt. Therefore, a
company which owns 10 percent
or more of the voting interest in an
electric utility is considered to be a
holding company under PUHCA.
In addition, all of the other
subsidiaries and affiliates of the
holding company would also be
subject to PUHCA. Unless it is
eligible for an exemption, a
holding company is required to
register with the Securities and
Exchange Commission. Such
registration subjects the registrant
to rigorous financial and
operational requirements as well
as burdensome provisions for
geographic and functional
integration of its facilities. Due to
the undesirable consequences of
becoming a registered holding
company under PUHCA, the
purchaser of a power generation
facility will want to exercise
careful diligence in establishing or
maintaining appropriate
exemptions from the registration
requirements of P U H C A . ~ ~
2. EPAGT. In 1992 Congress
enacted the Energy Policy Act of
1992 (EPACT), which
substantially amended PUHCA
and eliminated many of the
barriers to development,
acquisitions, and divestitures of
power generation fa~ilities.~'
In
order to facilitate the goal of
introducing competition into
previously regulated markets,
EPACT provides an exemption
from the regulations applicable to
owners of eligible generating
facilities producing power sold
exclusively into wholesale
markets. These entities are known
as exempt wholesale generators
(EWGs).By creating a new class of
generators exempt from the
rigorous regulatory scheme of
PUHCA, EPACT eliminated
many of the barriers for utility
affiliated and unaffiliated power
producers to construct, acquire,
own, and operate generation
fa~ilities.~"
n EWG is a company which
has applied to and been
determined by FERC to be
engaged exclusively in the business of owning and/or operating
an eligible facility selling electricity at wholesale. A person seeking EWG status must file with
FERC: (i) a sworn statement
attesting to the facts presented
that demonstrate eligibility for
EWG status; (ii) a brief description
c 2002, Elsevier Sclence hc., 1040-6190/02/$-see front matter PI1 51040-6190(02)00369-X 73
of the facility, related transmission
interconnection components,
and any lease arrangements
involved, and any public utility
company that is an affiliate of the
applicant; and (iii) any necessary
state commission determinations
required under EPACT. Although
a person is deemed to have EWG
status upon filing with FERC,
the buyer of the facilities will want
to obtain a formal eligibility
determination with respect to
such facilities before closing the
tran~action.~~
3. FPA. Virtually all
acquisitions involving wholesale
power marketers or transmission
service providers, including
EWGs, require FERC approval.
An entity which owns and/or
operates facilities used for the sale
of electric energy at wl~olesaleis
subject to the provisions of the
Federal Power Act (FPA) as a
"public utility." Section 203 of the
FPA requires a public utility to
obtain prior approval from FERC
for the sale, lease, or other
disposition of "jurisdictional
f a ~ i l i t i e s . "Jurisdictional
~~
facilities include all facilities used
for the transmission or sale of
electric energy in interstate
commerce, including:
(i) transmission facilities
interconnected to a network that
operates in interstate commerce,
including step-up transformers
and generation leads located at
generating plants;
(ii) distribution facilities that
are used in interstate commerce,
such as the delivery of power
across state boundaries;
(iii) wholesale power contracts
pertaining to transactions affecting interstate power grids; a i d
(iv) physical facilities, contracts, and boolts and records
pertaining to the foregoing.
rior to consummating the
transaction involving a disposition of a utility's assets or sale
of the utility, the seller must file
an application with FERC sup-
plying the following information:
(i) a statement identifying the
nature of the transaction subject to
FERC's jurisdiction under Section
203 of the FPA; (ii) the parties to
the transaction; (iii) the jurisdictional facilities affected; and (iv) a
statement explaining what effect,
if any, the proposed transaction
would have on the applicant's
market power.51
ection 203(a) of the FPA
provides that FERC must
approve the disposition of jurisdictional facilities if it finds that
the disposition "~7illbe consistent
with the public ii~terest."'~
In
making this finding, FERC generally takes into account the effect
on competition, the effect on rates,
and the effect on regulation.5'
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74
T 2002, Elsevier Science Inc , lO40-6190/02/$
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-
4. PURPA. The Public Utilities
Regulatory Policies Act of 1978
(PURPA) introduced a new type
of wholesale energy producer to
electricity markets. When it was
enacted, the objectives of PURPA
were to promote conservation of
electric energy, increase utility
efficiency and achieve equitable
consumer rates through the
development of cogeneration and
small power production. These
goals were to be achieved in part
by requiring electric utilities to
offer and to sell electric energy to
qualifying cogeneration facilities
and small power production
facilities as well as to purchase
electric energy from such facilities
at just and reasonable rates.
Under PURPA, qualifying
cogeneration facilities and
qualifying small power
production facilities (QFs) must
satisfy certain size, efficiency,
operating, and ownership
requirements in order to maintain
their status as a QF. QFs are
exempt from most of the rate and
corporate regulations that are
imposed on traditional electric
utilities under state and federal
law. These facilities are essentially
guaranteed a market for their
electric production by local
utilities at a rate corresponding to
the utility's marginal cost of
production. This rate includes its
energy and capacity costs, a
theoretically guaranteed
interconnection into a local
utility's grid, guaranteed access to
standby power by a local utility at
a nondiscriminatory rate, and
exemptions from various
provisions of the FPA, PUHCA
- - - --
see frontmatter PI1 51040-6190(02)00369-X
The Electricity Jot~rrzd
and certain state utility laws.
Although many of the advantages
of PURPA have become obsolete
due to emerging federal and state
open access and unbundling
legislation and regulations, many
of the benefits remain. A buyer
will want to be assured that a
facility which is represented to be
a QF does in fact meet all the
requirements of maintaining QF
status.
I . The TPUC. The TPUC
requires that all electric utilities
report any sale or acquisition of a
plant for an amount exceeding
$100,000." An electric utility is
defined as a person or river
authority that owns or operates
for compensation within the State
of Texas, equipment or facilities to
produce, generate, transmit,
distribute, sell, or furnish
. State law
There are many considerations
of state law to be made in the
context of purchases and divestures of power generation assets.
While some issues are raised
upon the change in control of the
facilities, the facility's historical
and current compliance with
state law must also be confirmed.
Texas law defines power generation assets to include all assets
associated with the production of
electricity, including generation
plants, the electrical connections
of the plant to the transmission
system, fuel contracts, fuel
transportation contracts, water
contracts, lands, surface or subsurface water rights, emissionsrelated allowances, and gas
pipeline interconnection^.^^
Whenever parties engage in the
purchase and sale of power generation assets in Texas, the principal administrative bodies
which have jurisdiction over the
transaction are the Texas Public
Utilities Commission (TPUC) and
the Texas Natural Resource
Conservation Commission
(TNRCC).
October 2002
electricity in this ~ t a t e . ~ V h e r e
are, however, several exclusions
to this rule, including a power
generation company (PGC), a QF,
~ ~ these
and an E W G . While
entities are not subject to any
TPUC reporting requirements
upon change of control, they are
subject to certain registration
requirements. In order to preserve
their status under state law, a
purchaser must be careful to
comply with the requirements
under which the facilities were
given their specified status. For
example, PGCs are subject to
extensive registration
requirements prior to
commencing operations. A PGC
is a company that generates
electricity intended to be sold at
(_
wholesale, but does not own
transmission or distribution
facilities, essential
interconnecting facilities, and
does not have a certified service
area.58A QF is defined as a
qualifying cogenerator or
qualifying small power
producer.s9 The term "qualifying
cogenerator" refers to the owner
and/or operator of a cogeneration
facility that the FERC determines
meets any requirements that the
FERC may from time to time
promulgate "and is owned by a
person not primarily engaged in
the sale of electric power (other
than electric power solely from
cogeneration facilities or small
power production fa~ilities)."~'
imilarly, an EWG must also
make certain registration
filings with the TPUC to establish
its status in Texas as an EWG.~'
An EWG is defined as a person (a)
who is engaged in the business of
owning or operating all or part of
a facility for generating electric
energy and selling electric energy
at wholesale; (b) who does not
own a facility for the transmission
of electricity, other than an
essential interconnecting facility
necessary to effect a sale of electric energy at wholesale; and (c)
who has registered with the
TPUC as an EWG." A buyer
should review the operations of
the seller to assure that the status
of the seller or the facilities will
enjoy the appropriate exemptions
and regulatory benefits as are
anticipated.
2.
CC. The TNRCC is the
Texas administrative body from
2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X 75
which operating permits must be
obtained in connection with the
purchase and sale of power
generation assets. Several
permits are required for the
operation of a power plant such
as those concerning air, waste
and water. These permits may
usually be transferred from the
seller to the buyer. Section 305.64
of Title 30 of the Texas
Administrative Code details the
process and requirements for
transferring TNRCC permits. A
permit may only be transferred
upon approval of the TNRCC. In
most cases, either the current
permit holder or the prospective
transferee must submit a transfer
application to the Executive
Director of the TNRCC at least 30
days before the proposed transfer
date. The application should
contain the name and address of
the transferee, the date of the
proposed transfer, and a $100
application fee. Any attempted
transfer will not be effective until
the TNRCC actually approves
of it. Therefore, if a buyer
causes or allows operation of the
facility before the transfer of the
permit is approved, it will be
deemed to be operating without a
permit.63
he procedure for the transfer of hazardous waste
permits is different. For these
permits, prior written approval
of the transfer must be obtained
from the Executive Director. The
parties to the transfer must submit a written agreement to the
Executive Director containing a
specific date for the transfer of
the permit and the buyer must
76
(
submit a revised permit application at least 90 days before the
scheduled tran~fer.~%sa condition of the transfer of hazardous waste permits, each of the
parties must also demonstrate
"financial assurance" to the
TNRCC. The seller must continue
to demonstrate its financial
responsibility for such things as
bodily injury or property damage
buyer adequately demonstrated
financial responsibility, he will
notify the seller that it no longer
needs to demonstrate such
assurance.
nless the parties agree
otherwise, responsibility
and liability for compliance with
the terms and conditions of the
permit(§) are to be assumed by the
buyer on the effective date of the
transfer. The Executive Director
must be satisfied of any required
financial responsibility before he
can forward the application to the
TNRCC for approval. Furthermore, the TNRCC may refuse to
approve a transfer where the
conditions of a judicial decree,
compliance agreement, or other
enforcement order have not been
entirely met.69
D. Analyzing the seller
to third parties arising from the
operations of the facility.65This is
accomplished through the continued maintenance of liability
ins~rance.~"inancial assurance
must also be demonstrated by the
seller for any costs that could be
incurred in the event of the closing of the plant or any other
necessary corrective action.67
This may be demonstrated in
several ways, such as the maintenance of an escrow fund or by
posting a security bond guaranteeing payment." Within six
months of the effective date of the
transfer, the buyer must begin to
demonstrate financial assurance
to the TNRCC for all of the above
matters. Upon the Executive
Director's satisfaction that the
2002, Elsevier Science Inc., 1040-6190/02/$- see front matter PI1 51040-6190(02)00369-X
It is not uncommon for power
generation assets to be owned by
a special purpose entity which
has been organized to hold its
assets and maintain its operations separate from the assets
and operations of its parent.
These types of bankruptcy
remote organizational structures
may serve any number of purposes from the perspective of the
seller, including the facilitation
of the project financing.
Regardless of the reasons for the
assets being held in the SPE, the
purchaser should carefully consider the organizational structure of the seller and the
governance documents to which
it is subject. Furthermore, the
purchaser should elicit strong
The Electricity Journal
representations from both the
Sponsor and the SPE w l ~ i c l ~
precisely describe the organizational rights and limitations of
the seller parties.
s in any acquisition, the
seller's representations in
the purchase and sale agreement
serve several important purposes. For example, they enable
the buyer to obtain reliable
information about the seller
before signing of the acquisition
agreement. Responsible sellers
will carefully draft representations which in turn provide
essential disclosures to the
buyer about the seller and the
seller's business operations. The
seller's representations also
provide the mechanism for the
buyer's right to terminate the
acquisition prior to the closing. If
the buyer's due diligence
uncovers adverse facts which are
contrary to the seller's reprel ~ buyer
sentations on w l ~ i c the
has relied in negotiating the
acquisition, the buyer's primary
recourse will be to terminate
the agreement or seek a discount
of the purchase price. The
scope and precision with which
the representations are written
will determine the outcome of
any controversy concerning a
breach of a representation. In
addition, the seller's representations directly relate to the
buyer's rights to indemnification
if a breach of a seller's representation is discovered after the
closing.
Notwithstanding the care and
precision with which the seller's
representations are drafted,
October 2002
unless the seller's existence and
financial viability survive the
closing for the duration of the
other surviving obligations of the
seller, the purchaser will effectively have no recourse for
enforcing its post-closing rights.
For example, if a seller makes a
misrepresentation about its liability under environmental laws
and the purchaser subsequently
incurs liability for the same violation, the purchaser should have
the ability to enforce its indemnification rights against a solvent
and viable entity. However, if the
purchaser has purchased all or
substantially all of the assets of an
SPE and the SPE has transferred
the proceeds up to its parent, the
purchaser will want to seek
recourse from the entity to which
the proceeds were transferred. It
is not uncommon for purchasers
to require that the corporate
parent or another financially
solvent entity assume joint and
several liability for the representations of an SPE.Alternatively,
the parties may negotiate a
reserve fund to be held in escrow
for an agreed period of time.
Regardless of what method is
used, the primary consideration
is the financial viability of the
entity standing behind the seller's representations after the
closing.
As discussed above, in a
divestiture of power generation
assets, the seller is likely to be an
SPE which, upon the closing, will
be selling all or substantially all of
its assets. Under these circumstances shareholder approval
may be required. Similarly, if the
SPE is owned by a joint venture,
the organizational and governance documents of the seller must
be carefully reviewed to assure
that the seller has proper
authority to consummate the
transaction.
Unless the facilities are to be
acquired subject to existing project financing and the Financing
Documents, the purchase and sale
agreement for a power generation
facility will likely be structured as
an asset purchase agreement.
Many of the issues raised will be
typical of ordinary negotiations
involving the sale of assets.
However, many industry-specific
issues will also be raised in the
preparation and negotiation of the
asset purchase agreement. The
following discussion focuses on
the principal provisions of an
asset purchase agreement and
raises a number of specific drafting issues which should be considered in a transaction involving
C 2002, Elsevier Science Inc ,1040 6190/02/S-see front matter PI1 S1040-6190(02)00369-X
77
the purchase and sale of a power
plant.70
together comprise the power
generation facilities necessary to
operate the project.
Assets to be sold
B. Excluded assets
The identity of the specific
assets to be transferred and the
liabilities to be assumed are the
centerpiece of an asset purchase
transaction. The acquisition
agreement and the schedules
should identify, in detail, the
assets that are to be acquired by
the buyer. The specificity of the
description may depend in part
upon the status of the buyer's
due diligence at the time the
acquisition agreement is executed. Typically, the description
of the purchased assets should
include a legal description of the
real property on which the
facilities are situated and
describe the facilities, including
the turbines, with as much particularity as possible. If the seller
is an SPE and all the assets are
being purchased, it may be better to start with the broad
reference to "all the assets" of
the SPE, "including, without
limitation," and then list the
assets with particularity. In
either event, the asset description should include reference to
the project agreements including
the Fuel Supply Agreement, the
Power Purchase Agreement, the
O&M Agreement, the EPC
Agreement, the IP Agreements,
and any permits and land use
rights necessary to operate the
facilities. The buyer's due diligence will be essential to
obtaining a comprel~ensivelist
of the seller's assets, which
78
The parties must also focus on
identifying the assets to be
excluded from the acquisition.
There may be many reasons for
excluding certain assets from the
transaction, including environmental liabilities associated with
certain properties or the desire of
a seller to remove one of the turbines from the facility. The
excluded assets may be described
generally or specifically, but the
specificity of this description will
generally follow the format utilized for listing the assets to be
purchased.
C. Consideration
The value of a plant and thus
the consideration to be paid will
be based upon a multitude of
factors including the plant's age,
condition, the type of fuel, and the
location. The projected demand
for power in the region sur-
c 2002, Elsewer Science Inc., 1040-6190/02/$- see front matter PI1 51040-6190(02)00369-X
rounding the plant and the regulatory climate for new
development and expansion will
also influence the ultimate purchase price of the facilities. These
and other factors affect the predictability of cash flow and
earnings of the facilities. The
financial analysis may begin with
a review of the volume of output
and efficiency of the plant. The
efficiency of the plant is determined by comparing the rates at
which the project converts fuel
supply into units of electricity.
Generally speaking, on the basis
of dollars-per-kW of capacity,
coal-fired plants are significantly
more expensive than natural-gasfired plants due to the variance in
operating costs. Steam turbine
gas plants have a higher production cost than coal plants, thus
the lower value attributable to the
gas plants. The demonstrated
reliability of plant operations and
avoidance of unplanned shutdowns due to mechanical breakdowns will also significantly
affect the value. Proven technological components of the plant
offer greater reliability and thus
higher value. Location of the
project will also influence value.
If a buyer is able to expand the
facilities without having to obtain
new site approval or permits, it
may be willing to pay more for the
existing facilities. Aside from the
physical characteristics of the
plant itself, the supply and offtake agreements which either
enhance or burden the project
will significantly affect the
amount of the consideration. The
amount of the purchase price will
The Electricity Jourrznl
also depend in large part upon
the extent to which liabilities
are assumed by the buyer. The
amount and type of liabilities a
buyer is willing to assume varies
with each transaction and the
assumption and retention of
liabilities will likely be a heavily
negotiated issue.
The outcome of the negotiation
regarding retention of liabilities
will depend upon the results of
the buyer's due diligence and
negotiations between the parties
on other economic matters. The
buyer should identify the liabilities it will assume with as much
specificity as practicable to
reduce the chance for unanticipated exposure. Liabilities which
may become the subject of
negotiation between the buyer
and seller of power facilities are
diverse, beginning with the project financing and the Financing
Documents themselves. If the
facilities are project financed and
the buyer does not wish to
assume the existing credit facility
on the project, there may be early
payment fees associated with the
project financing which must be
allocated between the parties.
There may also be a fee payable
to the lender or credit enhancer
upon change of control, even
if the buyer does assume the
project financing. In addition
to the project financing, there
may be other debts or liabilities
associated with the project.
For example, the Fuel Supply
Agreement may or may not be
October 2002
economically favorable and the
parties may need to negotiate
which party will be responsible
for the uneconomic portions of
the agreement. There may also be
project-related debt outstanding
in connection with capital
improvements, expansions, or
compliance with evolving legal
requirements such as new
environmental regulations.
Liabilities for open hedging
positions, operating leases,
accounts payable and reserves
for deferred expenditures such
as taxes and employee benefits
may also become issues for
negotiation.
nce the parties have
agreed on the specific
liabilities which the buyer will
assume, the buyer will expect the
seller to be responsible for and
pay all other liabilities. To the
extent that liabilities are retained
by the seller, the buyer will want
indemnification if it is forced to
pay any liability retained by the
seller. The division of liabilities
in this way requires the buyer to
have a good understanding of
the facilities and the seller's
8
operations which can only be
achieved through careful due
diligence.
he acquisition agreement
may provide that the buyer
is responsible for all liabilities
associated with operations from
the date the acquisition agreement is signed. Under this scenario, the buyer would only be
responsible for liabilities which
are incurred in the ordinary
course of business or otherwise
permitted in the agreement.
However, the parties may envision different standards of what
comprises the ordinary course of
business, for example, with
respect to maintenance costs,
capital expenditures, or sales of
power which have post-closing
effect. Therefore, the parties
should identify with specificity
their expectations for liabilities
and expenditures incurred in the
ordinary course of business
between the date of the agreement and the closing date. Once
the parties have agreed on the
allocation of operating liabilities,
it is customary to establish a
mecl~anismto adjust the purchase price based upon changes
in working capital and other
changes in the financial condition of the seller during the period between the date of the
delivery of the seller's financial
statements prior to the closing
and the effective date of the
purcl~aseagreement. This procedure permits the parties after
the closing date to accurately
reflect the seller's financial condition at the specified effective
date and allocate the liabilities in
f 2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 51040-6190(02)00369-X
79
accordance with the terms of the
agreement.
E, Allocations
The sale of the assets which
collectively comprise the power
project will be treated for federal
tax purposes as if there were a sale
of numerous individual assets.
Section 1060 of the Internal Revenue Code requires parties to the
transaction to each file a Form
8594 Asset Acquisition Statement
describing the allocation of value
of the assets transferred in the
transaction. In order to avoid IRS
scrutiny of the transaction, the
parties should agree in advance as
to how the purchase price is to be
allocated among tlne assets.
However, agreement between the
parties may not always be easy. If
a seller has a low basis in depreciated assets such as turbines or
other equipment, it will prefer to
assign a low value to these assets
in order to avoid recognizing
significant taxable gains at the
time of the sale. On the other
hand, the buyer will want to get a
sizable step-up and establish a
lnigh basis in the same equipment
so that it may depreciate and
amortize the purcl~aseprice
against income from plant
operations.
If the closing is to be conditioned upon receipt of consents,
approvals, permits, financing,
or other matters wit11 respect
to which the timing cannot
be accurately predicted, the
80
(
I
agreement should provide that
closing will take place on the
later of a date certain or a specified number of days after the
satisfaction of one or more conditions to closing. The termination sections of the agreement
should establish a firm date after
wlnich either of the parties may
terminate the agreement if the
closing has not occurred. The
parties may also agree that either
the buyer or seller may postpone
the closing for a specified period
of time if it is unable to satisfy a
condition.
resentations an
warranties
From the buyer's perspective,
the seller's representations are a
critical feature of the transaction.
They serve as the primary leverage for obtaining disclosure
about the seller and the facilities
before execution of the acquisition agreement. They also provide a foundation for the buyer's
right to terminate the acquisition
before the closing upon discovery
of adverse facts contrary to those
2002, Elsevier Sclence Inc., 1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X
represented by the seller. In
addition, the buyer's right to
indemnification by the seller after
the closing will be based upon a
breach of any representations
and warranties. However, the
scope and extent of the seller's
representations and warranties
may largely depend upon the
relative bargaining power of the
parties. If project facilities are
being marketed in an auction or
other competitive bid, for example, the buyer might scale down
the representations required of
the seller to improve its chances
of being the winning bidder.
Similarly, to the extent tlne buyer
becomes comfortable, through
due diligence, with the assets or
the risk associated with a particular aspect of the transaction, it
may scale back the representations required of the seller. For
example, if the facilities are a QF
wlnich sells a material portion of
its offtake to a utility at "avoided
cost" pricing and the buyer hopes
to continue selling power on that
basis, it will require tight representations regarding the status of
the seller and the facilities as a
QF. However, if the buyer
intends to sell the power to other
parties and will not be relying on
the QF status, this representation
could be scaled back or even
eliminated.
1. Ezforceabilit; authority;
no cozflict. Fundamental
representations which are
central to the transaction include
enforceability, authority, and
absence of conflict. Both the
buyer and seller must undertake
substantial due diligence to
assure that the agreement is
enforceable and that the seller
has the required authority to
consummate the deal. If
shareholder or venture partner
approval is required, the buyer
may want to require that it
be obtained before, or
contemporaneously with,
execution of the asset purchase
agreement.
he purpose of the no-conflict
representation is to assure
the buyer that, except as disclosed
in the schedules, the acquisition
will not violate or otherwise
trigger adverse consequences
under any legal or contractual
requirement applicable to the
seller. This provision may have a
broad scope because it requires
disclosure not only of legal violations, but also of other types of
adverse legal consequences that
may be triggered by the transfer
of the facilities. As it applies to
contractual defaults, this provision has particular relevance to
project documents such as the
Fuel Supply Agreement, the
Power Purchase Agreement, and
the O&M Agreement, which may
have anti-assignment provisions
requiring counterparty consent
based, among other things, on
the creditworthiness of the
buyer/assignee. Notwithstanding the buyer's representations, it
may be prudent to assure the
continuing viability of such
agreements by having the counterparties acknowledge and consent to the assignment and
continuing effect of the agreements after the closing.
s previously discussed, the
transfer of power generation facilities will likely be subject
to applicable federal, state, and
local laws and regulations. All
licenses, permits, and land use
regulations which have application only to the seller should be
scheduled by the seller under this
representation. If a project is
subject to rollback or other prop-
T
October 2002
erty tax concessions, the sale of
the facilities may trigger a reassessment of the project site or
create a current tax obligation at
the time of the sale. The seller
must use diligence in reviewing
and scheduling all relevant legal
requirements associated with the
transfer and sale of the facilities
and the buyer should be prepared
to carefully analyze the representations and schedules of the
seller.
2. QFIEWG representation. If
the facilities are a QF and the
buyer desires to maintain the QF
status after the closing, the seller
should give QF representations
and warranties. That is, the seller
should be able to represent that
the project is a QF under
applicable state and federal law
and that the seller has not taken
actions or made any omissions
prior to the closing which would
cause the facilities to lose QF
status. In addition, the seller
should specifically represent that
the facilities are presently
operating and have been operated
as cogeneration or small power
production facilities having the
ownership, operating, and
efficiency standards, which, in
accordance with applicable law,
cause the facility to be a QF. This
representation is important
because the plant economics may
rely on mandatory utility
purchases of power at avoided
costs and exemption from state
and federal regulatory filings. The
failure of the seller to maintain its
QF status could also contribute to
a breach of a representation under
one or more of the project
documents, which in turn could
trigger termination provisions of
the agreements which are to be
assigned to the buyer.
Similarly, if the facilities are
owned by an SPE, the equity
securities of which are being
acquired by the buyer, the seller
should represent and warrant that
the SPE is an EWG and that the
seller has not done anything to
jeopardize the SPE's status as an
EWG. For example, all sales of
power by an EWG must be made
at wholesale. If the SPE has violated the provisions of EPACT
which assure its EWG status, the
buyer could inadvertently
become subject to the SEC filing
requirements of PUHCA.~'
,c 2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 51040-6190(02)00369-X
81
3. Financial statements. If the
facilities are owned by an SPE or
operated as an autonomous
business unit, the delivery of
financial statements by the seller
and the representation by the
seller that the financial statements
have been prepared in accordance
with GAAP will be a meaningful
and important part of the
agreement. The buyer wants to
assure the quality and certainty of
cash flow as well as the historic
reliability of operations. On the
other hand, if the facilities have
been operated as part of a larger
business unit and the seller does
not have a history of independent
financial reporting with respect to
the facilities, separate financial
statements may not exist.
Although auditors may have
expressed an opinion concerning
the entire enterprise's financial
statements and will most likely
have reviewed financial
statements relating to the
acquired facilities, that level of
review would not be a sufficient
basis upon which the seller would
be able to state that the financial
statements of the facilities
standing alone have been
prepared in accordance with
GAAP. In this event, the seller's
representations about the plant
operations would have even more
significance.
4. Sufliciency of assets. As
previously discussed, the power
generation facilities and related
operations will likely be acquired
as a going concern. The purpose
of the representation regarding
sufficiency of assets is to confirm
82
that the various components,
which together constitute the
acquired assets, will be all those
necessary for the buyer to
continue operating the facility in
the same manner as it had been
operated by the seller. For
example, if any of the essential
assets, such as interconnection
facilities or natural gas storage
facilities, are owned by the
principal shareholders or other
third parties, the buyer may want
assurances that it will have use of
these assets on some reasonable
basis before entering into the
transaction with the seller.
5. No undisclosed liabilities.
Depending on the relative degree
of negotiating leverage of the
parties, a buyer may require the
seller to make broad
representations that there are no
undisclosed liabilities associated
with the facilities or any of the
assets. In this way, the buyer
seeks to avoid, to the extent
possible, any transfer liability to
which it might be subject under
the law of fraudulent transfer and
various doctrines in areas such as
2002, Elsevier Science Inc., 1040-6190/02/$ -see front matter PI1 S1040-6190(02)00369-X
environmental law. On the other
hand, the seller may substantially
narrow the scope of this
representation to extend only to
"liabilities of the type required to
be reflected as liabilities on a
balance sheet prepared in
accordance with GAAP."
However, the buyer will likely
want to be apprised of all types of
potential liabilities of the seller,
such as liabilities for employee
benefits, mechanics liens, claims
of vendors, or environmental
claims regardless of whether such
liabilities are sufficiently definite
to merit disclosure in the seller's
financial statements.
6. Taxes. The buyer must be
assured that all tax liabilities of
the seller associated with the
facilities have been satisfied as of
the closing date and the seller
should disclose all possible tax
issues that may arise in the
buyer's post-acquisition
operation of the facilities. By
obtaining assurances that the
seller has paid all of its taxes, the
buyer reduces the likelihood of
incurring successor liability for
the seller's unpaid taxes. For
example, some jurisdictions offer
tax abatements or provide for the
creation of reinvestment zones in
connection with power plants or
pollution control equipment
which permit certain taxes to be
abated or postponed for a period
of time. The availability of such
exemptions often requires strict
compliance with regulatory
procedures and may terminate
upon change of control of the
facilities. The seller should
The Electricity Journnl
disclose and the buyer should be
made aware, prior to the closing,
of the existence and status of any
such arrangements.
7. N o material adverse change.
The purchaser of an operating
power plant needs assurances
that the business operations it is
acquiring have not suffered any
materially adverse changes since
the date of the most recent
audited financial statements of
the seller. The seller may object to
giving this representation on the
basis that the buyer is buying
assets, rather than stock. As a
compromise, the parties may
specifically identify certain types
of changes in the operations or
facilities that the buyer would
regard as important enough to
warrant not going ahead with the
transaction. For example, such
changes might include the risk of
the project suffering a reduction
in productivity or output as a
result of outages or a loss of fuel
supply in sufficient quantities or
at acceptable prices.
8. Absence of certain changes
and events. A buyer needs to have
the most current information
possible regarding the facilities.
Therefore, the seller's
representation regarding changes
made by the seller and
information about other events
relevant to the facility is an
important part of the
representations and warranties
made by the seller. This
representation seeks information
about actions taken by the seller
or other events affecting the seller
October 2002
since the date of the audited
balance sheet which may affect
the buyer's plans and projection
of income and expenses. In
addition, this provision typically
requires disclosure of actions
taken by the seller in anticipation
of the acquisition, such as plant
shutdown for maintenance (or
lack thereof) or installation or
removal of equipment.
9. Intellectual property (IP)
assets. The buyer should require
the seller to list all material IP
assets relating to the facilities,
including all software license
agreements, agreements
regarding the use of energy
efficiency technology and other
agreements that relate to the IP
assets, such as noncompetition
agreements, confidentiality
agreements, and maintenance
and support agreements for any
software the seller is licensed to
use. These disclosures enable the
buyer to identify which of the IP
assets are subject to restrictions
limiting the buyer's right to
exclusive use of the assets. The
seller should represent that no
default exists with respect to the
IP assets and that the sale of the
facilities will not trigger a
termination of any rights with
respect to such assets.
10. Solvency. If the facilities are
being acquired in a distressed
sale, a seller's solvency
representation may be included to
address the risk of acquiring
assets in a transaction which
could be characterized as a
fraudulent transfer by the seller.
This representation may be
required by the lender financing
the acquisition of the project.
Since financial statements of
the seller will be based on
GAAP rather than the fair
valuation principles applicable
under fraudulent transfer laws,
the buyer may seek further
assurance as to fraudulent
transfer risks by obtaining a
solvency opinion or a third-party
appraisal in order to establish that
the assets are being acquired in a
reasonably equivalent exchange
for value.
11. Disclosure schedules. The
disclosure schedules delivered by
the seller will contain most, if not
all, of the relevant information
about the facilities which
constitute exceptions to the
otherwise "clean"
representations made by the seller
with regard to itself or the
facilities. The schedules should be
carefully reviewed and studied
prior to executing the acquisition
agreement. If for any reason the
parties agree to sign the
acquisition agreement before
delivery of the schedules, the
2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X 83
parties should agree that the
schedules will be delivered by a
date far enough in advance of the
closing to permit a thorough
review by the buyer and an
analysis of the consequences of
disclosed items. Furthermore, the
date should be far enough in
advance so that the buyer has the
right to terminate the agreement
if there are any disclosures it finds
objectionable in its sole
discretion. Without such
assurances, the buyer will have
insufficient time to obtain the
required permits or consents
prior to the closing.
plant operations (except those
which would result in liability
of the seller).
1. Notification. The seller will
typically be obligated to notify the
buyer if it discovers inaccuracies
in the representations or if
material changes occur which
would cause a representation
in the acquisition agreement to
I. Conditions precedent to
buyer's obligation to close
H. Covenants of seller
prior to closing
The covenants of the seller
which are effective between the
date of signing the acquisition
agreement and the closing date
are designed to maintain, to the
extent possible, the project's status quo until the conditions of
closing can be satisfied and the
transaction consummated. The
covenants are also designed to
solicit the seller's good faith
assistance in bringing the transaction to a swift and successful
conclusion. The seller will typically be prohibited from taking
actions outside the ordinary
course of business and from taking other specified actions
between the signing date and
the closing date. Such prohibitions may include the making
of capital expenditures, making
any material operational changes
with respect to the plant or the
operator, or shutting down
84
will likely be numerous consents
and approvals with respect to
the transfer of permits, licenses,
and contracts with third parties
which require the diligence
and involvement of the seller.
The seller's failure to exercise
diligence in connection with
these matters that require its
active assistance may expose
the seller to liability to the
buyer.
be inaccurate as of the closing
date. The buyer's obligation
to complete the acquisition of
the facilities is subject to the
seller's representations being
materially correct both as of the
date when the acquisition
agreement was signed and the
date of closing.
2. Best efforts. The seller
should be required to use its
best efforts to satisfy the buyer's
conditions to closing which
are within its control. In this
regard, the buyer should
receive assurances from the
seller that it has exercised
reasonable diligence in causing
the conditions of closing to be
satisfied. For example, there
2002, Elsevier Science Inc., 1040-6190/02/$ -see front matter PI1 S1040-6190(02)00369-X
The buyer's obligation to consummate the acquisition of the
facilities will be subject to conditions precedent which constitute a
checklist of matters which must
be satisfied before the buyer is
obligated to proceed with the
acquisition and close the transaction. Unlike representations,
warranties, and covenants, the
failure of a seller to satisfy a
condition of closing will not
necessarily result in liability to the
seller. If the seller fails to satisfy a
closing condition, the buyer will
simply have the right to terminate
the acquisition.
1. Accuracy of representations.
As discussed above, the accuracy
of the seller's representations
serve as conditions precedent
to the buyer's obligation to close
the transaction. In this regard, the
seller's representations serve a
dual purpose. In addition to
providing the buyer with a
basis for recovering damages
against the seller for breaches
of the representations, they
The Electricity Journal
~~
~
2. Seller performance. The
seller's pre-closing covenants
also function as closing
conditions. If the seller materially
breaches any of its pre-closing
covenants, the buyer will have
the right to terminate the
agreement. Separately, it may also
have the right to sue and recover
damages because of the breach. In
some instances the agreement
also establish some of the
circumstances under which the
buyer would be permitted to
terminate the transaction if for
any reason any of the
representations are untrue when
made or become inaccurate as
of the closing date. The parties
may agree to measure the
materiality of any inaccuracies in
the seller's representations by
considering the representations
of the seller on both an
individual basis or on a collective
basis. In such event, the buyer
would be able to terminate the
acquisition if several individual
representations contained
inaccuracies which, considered
independently, would not be
significant but, considered
together, reach the overall
materiality threshold which
would justify a termination or
renegotiation of the agreement.
For example, the termination or
default of one or more power
sales agreements might not
individually rise to the requisite
level of materiality to establish
the occurrence of a materially
adverse change. At the same
time, a drop in current energy
prices might also be considered
immaterial taken alone.
However, the combination of
losing one or more power
customers in a time of declining
energy prices, considered
together, may cause one or more
of the buyer's representations
made at the time of signing the
purchase agreement to be
inaccurate at the time of closing
due to the combined effect of
changed circumstances.
October 2002
may be structured so that the
buyer can waive the condition of
seller's performance, forego its
right to terminate the agreement,
close the transaction, and sue the
seller after the closing for
damages based on breach of the
covenant.
3. Consents. The disclosure
scl~edulesshould list all consents
that must be obtained in
connection with the execution
and delivery of the agreement as
well as the consummation and
performance of the transactions
contemplated by the agreement.
Such consents will likely be
required from counterparties to
the project documents such as the
Fuel Supply Agreement, the
(
Power Purchase Agreement, the
O&M Agreement and the EPC
Agreement. Moreover, obtaining
such consents may be subject to
the buyer establishing itself to be a
creditworthy counterparty under
one or more of these project
agreements. The failure to obtain
a consent which is required as a
condition of closing will permit
the buyer to terminate the
agreement without liability to the
seller. To avoid cancellation of the
transaction on the basis of
immaterial issues, the parties may
negotiate which of the required
consents are significant enough to
justify allowing the buyer to
terminate the acquisition if the
consent cannot be obtained. On
the other hand, the seller should
also have the affirmative
obligation to exercise diligence in
obtaining or assisting the buyer in
acquiring the consents necessary
to consummate the transaction.
4. No proceedi~gs.If any
litigation relating to the facilities
or the acquisition is commenced
or threatened against the seller or
its affiliates which would in any
way adversely affect the facilities,
the buyer should have the right to
terminate the agreement.
However, the seller may seek to
narrow this condition by arguing
that the threatened or pending
lawsuits are without merit. In this
circumstance, the parties may
agree that the buyer would have a
right to terminate the acquisition
if a governmental body has
brought, or threatened to bring, a
lawsuit against the seller in
connection with the acquisition,
2002, Elsevier Science Inc ,1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X
85
but not if a private party has
brought or threatened to bring
such a lawsuit. This approach
addresses most environmental
and other regulatory actions
which tend to have serious
adverse consequences for a
project
5 . No conflict. Similarly, the
buyer should generally have the
right to terminate the acquisition
if any law, regulation, or other
legal requirement would be
violated as a result of the
acquisition. For example, if a state
or federal environmental agency
has the ability to void a sale or
assess fines if no environmental
clean-up plan has been filed or if
the provisions of PUHCA become
applicable to the buyer as a result
of the transaction, a buyer should
identify such regulations and
require compliance to be a
condition to the closing. On the
other hand, the buyer should
probably not be permitted to
terminate the acquisition merely
because of perceived adverse
changes in the regulatory climate
in the energy industry. In other
words, the buyer should only be
permitted to terminate the
acquisition if the transaction
would trigger a violation of an
existing legal requirement or if
significant changes in existing
statutes or regulations occurred
since the signing date which
justify the buyer's refusal to
complete the acquisition. Such
issues may become highly
negotiated and result in the
inclusion of specific provisions
regarding legal and regulatory
56
circumstances under which the
buyer would be permitted to
terminate the agreement.
J. Termination
The termination provisions of
the acquisition agreement set
forth the circumstances under
which one of the parties may
terminate its remaining obliga-
party. For example, the terminating party may be able to
recover its costs of conducting
due diligence, including its
attorneys fees, if the breached
representation caused the terminating party to expend sums
which it would not have spent if
the representation had not been
made or had been true and
accurate.
K. Indemnification; remedies
tions under the agreement before
the closing without incurring
liability to the other party. Termination rights may be available
to one of the parties if it becomes
clear that a condition to the other
party's obligations, such as
obtaining one or more consents
to assignment of a project
document, cannot be fulfilled by
the established date set for the
closing. However, the right of a
party to terminate the acquisition agreement does not necessarily mean that the other party
does not have continuing liabilities to the terminating party if
the other party has committed a
material default or breach of a
representation that results in
damages to the terminating
1 2002, Elsevier Science Inc., 1040-6190/02/$ - see front matter PI1 51040-6190(02)00369-X
The parties to a purchase and
sale agreement typically indemnify one another for any breaches
of representations, warranties,
and covenants. Indemnification
provisions establish contractual
remedies on which parties may
rely in the event of a breach or
other specified circumstances.
Without the express provisions
set forth in an indemnification
provision, a party's sole recourse
for misrepresentations by the
other party would be common
law causes of action. If the seller is
an SPE, the buyer may seek to
impose liability and financial
responsibility not only on the
seller, but also on its shareholders,
for breaches of representations
and covenants in the acquisition
agreement and for other specified
matters. However, indemnifications are not usually given by
public companies due to the difficulty in obtaining indemnification agreements from a large
number of stockholders. In addition, more often than not, there
will be no corresponding indemnification by the buyer to the
seller for a breach of the buyer's
The Electricity Jourml
representations, warranties, and
covenants because the buyer's
representations, warranties, and
covenants are usually not extensive. An exception to this rule
arises when the buyer agrees to
pay the purchase price with its
securities or where a portion of
the purchase price is deferred.
In this instance, the seller has a
strong incentive to insist on
extensive representations,
warranties, and covenants
which are supported by an
indemnification of the buyer.
The acquisition agreement may
also include special indemnifications for the breach of specific
covenants regarding tax and
environmental matters which
may not be adequately covered
by a general indemnification
provision.
ndemnification provisions
often include "caps" and
"baskets" which limit or otherwise control the applicability of
the indemnity. In negotiating for a
cap, a party seeks to impose a
ceiling above which the indemnification obligation cannot
extend. Parties will often agree to
a cap equal to the purchase price.
However, parties may agree that
different ceilings will apply to
different types of liabilities. In
negotiating for a basket, the parties will establish a materiality
threshold as the minimum
amount of damages which must
be incurred before any claim for
indemnification may be asserted.
Once a claim reaches the agreed
upon minimum amount, the
claimant would typically be able
to recover its damages from the
October 2002
first dollar. Finally, the parties
will usually provide for a time
limit within which the claim for
indemnification must be asserted.
Establishing a predetermined
limitations period for claims
contractually alters the statutory
limitations period within which
such claims could otherwise be
made. Most time limits range
between one and 10 years
depending on the type of damage
claims. Longer limits are often
applied for tax and environmental
claims.
to market risk, financing, the
physical project facilities, project
operations, and project agreements. Especially in this time of
industry turmoil, due diligence is
the most important element for
success. Documentation of transactions involving electric generation assets requires an
understanding of the legal, regulatory, operational, and contractual issues related to the power
industry. This article is not
intended to present an exhaustive
discussion of issues created by
recent developments. Rather, it
addresses some of the most fundamental considerations of which
parties must be aware in the
course of buying or selling facilities. With each transaction
comes the possibility of unique
and challenging obstacles.
Nevertheless, this roadmap may
be a resource for assisting both
buyers and sellers to achieve
successful and mutually beneficial results..
Endnotes:
VI. Conclusion
The power industry has
experienced a great deal of
change in a relatively short
amount of time. These changes
will likely result in industry consolidation and the movement of
assets among industry participants. Successful transactions
involving acquisitions and divestitures of power generation facilities require analysis of several
principal component parts. Careful consideration should be given
f=
1. Energy Information Association,
Tlze Clzanging Structure of Electric Power
bzdustry 1999: Mergers and Other Corporate Coinbifzatiom, Executive S u ~ n i n n l y
(Jan. 25, 20021, Ch. 6, at 2, available at
http: / /avsvw.eia.doe.gov/electrcity/
corp-str/chapter6.l1tml.
2. 2 ENERGY
LAW& TRANSACTIONS,
VOL.
52 (Matthew Bender & Co., Inc. 2001).
3. Id.
4. Will McNamara, "Liue" from Hous-
ton and CBI's 6 t h Amzral Mercha~zt
Elzergy Corzfereizce: Clzallenges fhnt the
Merchant Power Bzrsi?zess Will Face iiz
2002 (Part 11, The Power Marketing
Association Online Power Report (Tan.
29, 2002), available at http://
www.powermarketers.com.
2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 S1040-6190(02)00369-X 87
5. Id.
6. Michael Davis, W a f t ' s Going O n ,
HOUSTOX
C~noiurcr.~,
Jan. 27, 2002, at
3D.
7. McNamara, supra note 4.
8. Davis, supra note 6.
9. Davis, supra note 6.
10. Acquiring and Divesting Distressed Projects, address at Bodington
& Co., Dec. 4, 2001.
11. Cindy Tindell, How Lenders
Evaluate Project Structures and Credit
Issues, address at Infocast, Inc., New
York, April 23-25, 2001.
12. David A. Freeman, The Impact
of Fuel Supply on Getting Projects
Financed, address at Infocast, Inc.,
New York, April 23-25, 2001.
13. Tindell, s~ipranote 11; Ayaz R.
Shaikh, Esq., Negotiating Project
Agreements, address at Infocast, Inc.,
New York, April 23-25, 2001.
14. Id.; James Penrose and Peter
Rigby, Debt Rating Criteria for Energy,
I~zdtrsfrial,and Infrasfructzrre Project
Finance, March 19, 2001, available at
http:/ /www.standardandpoors.com./
australiaNZ/resourcecentre/methodology/corporateinfrastructure/
165926f.html.
15. Shaikh, supra note 13.
16. Penrose and Rigby, supra note 14.
17. Tindell, strpra note 11; Shaikh;
s z r p r m o t e 13.
18. Tindell, szrpra note 11; Peter N.
Rigby, The Role of Credit Ratings in
Project Financed Transactions, address
at Infocast, Inc., New York, April 2325,2001; Penrose and Rigby, supra note
14.
19. 729 S.W.2d 768 (Tex. App.Houston [lst Dist.] 1987, writ ref'd
n.r.e.). In Texaco, bzc., applying New
York substantive law, the court held
that a four page "memorandum of
agreement" sufficiently expressed the
intention of Gordon Getty and the J.
Paul Getty Museum to contract with
Pennzoil, Co. for the purchase of 100
percent of the shares of Getty Oil so
as to give rise to a cause of action
against Texaco, Inc. for inducing
Getty and the Museum to refuse to
88
29. Id. Provisions of this sort may
operate to prevent a board of directors
from acting on other, more attractive
offers, thus having a potentially ad20. SIMON
M. LORNE
& J01 MARLTNE
verse effect on the board's ability to
AND MERCERS:
NEBRYAN,
ACQUISITIOKS
fulfill fiduciary duties to the corporaGOTI,\TED AND CONTESTED
TRANSACTIONS,tion. MILLS
ACQUISITION
CO. \ . MACMILH. KNEE,
Ch. 3, § 3:54 (2001); STEPHEN
LAL, INC.,559 A.2d 1261, 1284 (Del.
EsQ.,Nmv JI:IGEY
PR~ICTICE
SERIES:
BUYING 1988). As a result, such provision are
AND SELLING
BUSINESSES,
Ch. 52, § 3460
closely scrutinized by the courts. Id.
(1996).
30. Knee, supra note 20, at n.2. Like
21. Knee, supra note 20.
lock-up provisions, no-shop provisions
are held to a high level of scrutiny by
22. Id.
the court as they too may prevent a
board of directors from considering a
higher bid. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506
A.2d 173, 184 (Del. 1985). A variation
of the standard "no shop" provision is
the so-called "window shop" provision allowing the seller to consider
unsolicited bids and, under certain
circumstances, to terminate the letter
of intent. Knee, supra note 20. Such
provisions are generally more in line
with the fiduciary duties that a board
of directors owes to a corporation. Id.
sell to Pennzoil despite Texaco's
knowledge of the memorandum. Id.,
at 789-796.
23. John Wood Group USA, Inc. v.
ICO, Inc., 26 S.W.3d 12, 16 (Tex.
App.-Houston [lst Dist.] 2000, pet.
denied).
24. Id., at 19. See also Texaco, I m . , 729
S.W.2d, at 790. In Texaco, bzc., the
court held that a memorandum of
agreement expressed the parties intent to be bound to by all provisions
where no attempt was made to specify
if any terms were meant to be nonbinding. Id.
25. ICO, Irzc., 26 S.W.3d, at 20. Under
Texas law, absent performance to the
contrary by the parties, "non-binding"
is an unambiguous term and any
provision labeled as such will not be
binding as a matter of law. Id.
26. Texaco, Irzc., 729 S.W.2d, at 790.
Parties should avoid stating what they
"will do" or "shall do." Id.
28. Id.
2002, Elserier Science Inc., 1040-6190/02/$-see front matter PI1 51040-6190(02)00369-X
31. Conzpre Venture Assoc. Corp. v.
Zenith Data Sys. Corp., 96 F.3d 275,
277-278 (7th Cir. 1996) and ICO, Irzc.,
26 S.W.3d, at 21. In Venture Assoc., the
7th Circuit, interpreting Illinois law,
held two parties to be contractually
bound by a letter of intent provision
calling for the parties to continue to
negotiate in good faith toward the
execution of a definitive agreement
despite the fact that the entire letter of
intent was expressly non-binding.
Venture Assoc., 96 F.3d, at 277. In Texas,
however, agreements to negotiate in
the future are unenforceable regardless
of the intent of the parties. ICO, bzc., 26
S.W.3d, at 21.
32. Knee, supra note 20. While it is
prudent to recite the payment of
consideration in the letter of intent,
any bargained for legal benefit or
detriment will be valid consideration.
Execution of the letter of intent itself
may serve as consideration where
such execution is bargained for by
either party and is of any value to that
party. Channel Home Ctrs. v. Grossman, 795 F.2d 291,300 (3rd Cir. 1986)
(holding that the mere execution of a
letter of intent was valid consideration
to support an exclusivity provision
The Electricity Joz~~nznl
where the landlord bargained for
the execution of the letter of intent
in order to facilitate obtaining
further financing for the purchase
of a shopping mall).
-
33. See Zander v. Ogihara Corp., 540
N.W.2d 702, 706 (Mich. Ct. April 1995)
(holding that where it could not be
proven that the defendant signed a
letter of intent, the statute of frauds
had not been satisfied making the
letter of intent unenforceable as a
matter of law); Prilla v. Bonnucci, 467
A.2d 821, 824 (Pa. Super. Ct. 1983)
(holding that letters of intent that had
been signed by the officers of two
corporations as agents for individual
shareholders to facilitate a stock sale
had been signed by the parties against
whom enforcement was sought so as
to satisfy the statute of frauds).
34. KELLY
KUNSCH,
WASIHINGTON
PRACSERIES:
BUYIKG
OR SELLING
A GOING
BUSINESS,
§ 73.4 (4th ed., 1997).
TICE
35. Id.
49. 2 ENLRG>
L I\\/ & TI<~ N S A C T I O N ~\ ,OL.
52 (Matthew Bender & Co., Inc., 2001).
services, if any, provided by the
registering party that pertain to the
generation of electricity. 16 TEX.ADLIIN.
50. 16 U.S.C. g 824b(a) (2000).
CODE§ 25.109(e)(2002);TEX.UTIL.CODE
51. 3 ENERGY
LAIV& TR~~NSACTIONS,
\ OL.
ANN.§ 39.351 (Vernon 2001). Additionally, for each generating facility
46-73 (Matthew Bender & Co., Inc.,
2001).
located with the state, the registering
party must provide (4) a description of
52. 16 U.S.C. 5 824b(a) (2000).
the type of services to be provided; (5)
53. 2 ENERGY
LA\V& TR.~KSKTIONS,
1.0~. a copy of any information required to
be filed with FERC in connection wit11
52 (Matthew Bender & Co., Inc., 2001).
registration wit11 that commission; (6)
See also MEP Pleasant Hill, L.L.C.,
the legal name of the registering party
MEP Pleasant Hill Operating, L.L.C.,
and any trade name under which the
and CPN Pleasant Hill Operating
registering party intends to operate; (7)
the registering party's Texas business
address and its principal place of
business; (8) the name, title, address,
telephone number, fax number, and email address of the person to whom
communications should be addressed;
(9) the names and types of businesses
of the registering party's parent company, if any; and (10) power rating in
megawatts. 16 TEX.ADMN.CODE5
25.109(e)(2002);TEX.UTIL.CODEANN.5
39.351.
-
36. Id.
37. Knee, szipra note 20.
38. Shaikh, strpra note, 13; John E.
Dickinson, Negotiating and Drafting
Contracts for the Sale of Natural Gas to
End Users (on file with author); Rigby,
supra note 18.
39. Dan R. King and Douglas S. Bland,
Selected Issues in Merchant Plant
Development Today (Aug. 18,2000).
40. Lisa M. Tonery and Ayaz Shaikl~,
Negotiating and Documenting the Key
Project Agreements, address at Infocast, Inc., New York, April 25, 2001.
L.L.C., Docket Nos. EL01-119-000 and
EC01-155-000 [2001] 97 F.E.R.C. (CCH)
n 61, 803; Inquiry Concerning the
Commissions Merger Policy Under the
Federal Power Act: Policy Statement,
Order no. 592, 61 Fed. Reg. 68,595
(Dec. 30, 1996).
60. 16 TEx. ADalIN. CODE5
25.5(56)(2002);16 U.S.C. 3 796(18)(A)(C).
63. See 30 TEX.ADZIIN.
CODE§
305.64(a), (b) & (el (2002).
64. Id., at § 305.64(g).
41. Shaikl~,supra note 13.
42. Rigby, supra note 18; Tindell, supra
note 11.
43. Rigby, supra note 18; Tindell, supra
note 11; Penrose and Rigby, supra note
14.
45. S11aikl1, szipra note 13.
52 (Matthew Bender & Co., Inc., 2001).
47. Energy Policy Act of 1992, Publ.
No. 102-486, 106 Stat. 2776 (1992).
48. Id.
October 2002
66. Id.
67. Id. at g37.6021.
58. Id., at 5 25.5(47). If a person
qualifies as a PGC, they must register
with the TPUC prior to the first day of
generating electricity. Id., at §
25.109(a)(1)-(2);TEX.UTIL.CODEANN.§
39.351 (Vernon Supp. 2002). Registration requires filing with the TPUC (1)
the location by county, utility service
area, control area, power region, and
reliability council; (2) the name of the
facility; (3) a description of the types of
69. Id., at (c)-(d), (f)-(g).
70. See Byron F. Egan ef al., Negotiating Business Acquisitions-Asset
Deals (MAPA), in ABA National Institute on Negotiating Business Acquisitions, Boca Raton, FL (Nov. 7,
2000), available at http://jw.com/articles/articles.cfm.
71. Tonery and Shaikl~,strpra note 40.
C 2002, Elsevier Science Inc., 1040-6190/02/$-see front matter PI1 51040-6190(02)00369-X 89