Point Energy Innovations recently published a white paper titled “Profiting from the Sun: How Building Developers Can Unlock the Country’s Largest Potential for Renewable Energy—Quickly and Profitably,” which discusses the nation’s need for sustainable energy and options for financing and recouping investments in rooftop solar.

Michael Polentz, a partner and co-chair of Manatt’s real estate practice group, was interviewed by Point Energy Innovations as part of its diligence for the white paper. Michael offered insights into the legal basics of investing in solar, structuring solar transactions, cost recovery for commercial property owners and overcoming regulatory restrictions.

From a legal perspective, what are the easiest ways for developers to recover costs of solar?

The larger discussion point on the economics of solar goes back to the split incentive problem that has driven a wedge between landlords and tenants in triple net (NNN) leases for many years. For example, the tenant will typically pay the utility bills directly under a NNN lease, and thus, the tenant will see the primary benefit from the installation of solar through a reduction in utility expenses. Moreover, in most instances the cost of the solar constitutes a capital improvement under a NNN lease that falls on the landlord (and not the tenant) to cover. There are models that avoid or mitigate the split incentive problem, and entrepreneurial landlords are using them in the current marketplace. These include, but are not limited to, (1) solar leases and solar PPAs; (2) gross or modified gross lease structures; (3) cost sharing arrangements between landlords and tenants when collaborating for a more energy-efficient building or premises; (4) incentivizing the tenants to participate in the overall efficiency/sustainability model; (5) higher rents for sustainable premises and buildings; and (6) longer lease terms that help with the capital cost amortization if the landlord is funding the purchase and installation of the solar.

What are the implications of PPAs vs. selling electricity or a green surcharge?

There are legal restrictions and hurdles that limit when and how a party can sell electricity. The easy distinction is that a PPA involves a third-party provider that purchases, installs and operates the solar systems and sells the electricity generated to the landlord or the tenant. Potential risks arise, however, if the landlord wants to “sell” the electricity to the tenant in California because any person or corporation that provides a regulated service to or delivers a regulated commodity to the public or any portion thereof for which any compensation or payment is received becomes a public utility under California law. As you might expect, landlords do not want to be deemed public utilities and will therefore often be reluctant to jump into this structure. There are exceptions for solar power; however, these exceptions are limited under existing laws. The statutory language relates to any corporation that “directly or indirectly” delivers or sells “heat” or where the solar electrical power is distributed by the producer, especially for its own use or its tenants. The challenge is that this exemption does not address the following potential areas: (1) where the reseller/property owner or manager is not the producer of the solar electrical power; (2) where the power is delivered and consumed outside the property where it is produced or immediately adjacent thereto; (3) where the sale is to more than two corporations (except for shopping centers with central plants or mobile home parks); (4) where the sale is to a utility in the first instance; (5) where the solar power is commingled with utility-based services (i.e., where the solar power supplements utility service); and (6) where the reseller charges more for the commodity and service than the sum of the actual costs of the components of the service (a markup). The good news is that there are ways to avoid these pitfalls (assuming the landlord is not attempting to charge more money for the power than the local utility would charge), but they require landlords and tenants to work closely with their respective legal advisors when preparing the leases.