Even after the retrospective cut in renewable energy incentives in Italy, the acquisition of operating solar photovoltaic (PV) plants under the right conditions still provides strong financial returns to investors.
Nonetheless, irrespective of a project's financing structure or size, there are risks associated with such transactions which buyers should be aware of during the due diligence process.
A thorough legal due diligence exercise should cover a wide range of issues, including:
- land rights;
- permits and environmental aspects;
- grid connection rights;
- corporate aspects;
- any construction aspects that may be relevant;
- operations and maintenance; and
- any existing financing agreements.
Property due diligence is initially required to establish whether the development of a PV plant was allowed from a development planning perspective. If it emerges that, at the time of the construction work, the site had a cadastral classification that was, in principle, unsuitable for the installation of the PV plant or that the site was located within an area of special environmental value (eg, a special preservation zone or a site of European significance), it will be necessary to establish whether:
- the local authority amended the land's cadastral classification; or
- specific environmental proceedings were carried out to evaluate the project's potential impact on the environment.
To ensure that planning permits were legitimately issued and incentives are lawfully paid, it is necessary to establish whether the developer:
- had rights to the requisite land for the site where the PV plant was built at the start of the authorisation procedure; and
- continued to hold such rights during the incentive period.
The nature of land rights (eg, proprietary rights versus land leases) that provide project developers with authorised use of a site may impact a project's bankability, as banks usually require security on the land itself.
It is standard for a 20 to 25-year surface right to be granted, often with an option to renew for a further period if the project remains operational. A buyer should ensure that the duration of the surface right is aligned with that of the incentive period at no extra cost. In the case of rooftop PV installations, the building owner must grant the project special purpose vehicle (SPV) full access to the roof in accordance with health and safety regulations. Further, responsibility for maintenance of the building, the roof and the PV plant must be allocated correctly.
In the context of the property due diligence process, legal and technical advisers should review searches at the land registry to ensure that:
- the site is not affected by prejudicial encumbrances or third-party rights (eg, pledges, civic uses or pre-emption rights); and
- all titles affecting the site are reported on.
However, excerpts from the land registry have limited legal value and the assurances that the SPV has acquired land rights from the landowner and that no prejudicial encumbrances affect the site may be obtained only through a 20-year notarial report prepared by a public notary. A 20-year notarial report may be a useful instrument to understand if the root of title over the land is valid, allowing a purchaser to take adequate remedies in a sale and purchase agreement (SPA) in connection with the findings of the notary search.
If the 20-year notarial report shows that titles to the site have been transferred through a donation or under a will, there is a risk that legitimate heirs may be entitled to:
- make a legal claim that the donations made by the deceased or the provisions of his or her will have prejudiced the mandatory quota of the estate reserved to them by law; and
- ask for the restitution of the site or payment of its value.
The buyer will expect a full indemnity against any losses or expenses arising from any claims that may be brought by legitimate heirs in order to pay them and avoid restitution of the site.
It is advisable that a buyer's advisers review the 20-year notarial report's findings well in advance of the signing date to verify that potential encumbrances (eg, foreclosures and mortgages) or other issues (eg, unregistered property rights or the existence of donations or wills) are known in advance and adequate protections are contemplated in the SPA.
A key part of the property due diligence process is to check that the SPV has the right to lay a cable to the grid connection point. If the grid connection work was not conducted by the grid operator, full due diligence will be required with the same level of detail as previously carried out for the project site itself. It is also crucial to identify where electrical cables cross roads or other infrastructure (eg, gas or water pipelines) so that it can be established whether the necessary consents have been obtained from the competent authority. Concessions for the use of public land can trigger annual fees and taxes to be paid to the local authorities.
Buyers must seek to confirm that:
- all permits are valid and effective and that there is no risk of judicial review;
- no additional planning permit is necessary; and
- the conditions set out in such permits (eg, in terms of distances from buffer zones and environmental mitigation measures) have been complied with.
In the secondary market, the risk that third parties may challenge planning authorisations is remote due to the expiry of the statutory appeal terms. Nonetheless, an assessment of this risk may still be required in the event that new post-completion authorisations are granted to:
- implement changes to the original authorised project; or
- rectify discrepancies between the as-built and the authorised project design.
In this respect, it is crucial to understand whether changes are material. If so, the authorisation procedure will be more complicated and the entitlement to incentives may be at risk.
Further, any public authority is entitled to act in self-defence and annul a formerly approved administrative act when it becomes apparent that:
- the relevant act was issued in breach of the law; and
- an actual public interest exists to support the act's annulment.
According to recent changes to the law, the power to annul in self-defence must be lawfully exercised within 18 months; however, this time limit is subject to exceptions. A potential buyer should confirm that no circumstances exist that could lead the public authorities to start an action in self-defence.
The risk of third-party challenges and public authority actions in self-defence against planning authorisations decreases with time after a PV plant enters into operation. However, there is still a residual risk of forfeiture or the revocation of incentives due to facts or circumstances that existed prior to their award. From a legal perspective, risk assessment is the most important exercise to be carried out. The Energy Services Manager (GSE) – a state-owned entity that promotes the development of renewable energy sources – has a general power of inspection of PV plants. Depending on the seriousness of the violation, the GSE may order the suspension or revocation of incentives and seek to recover all sums paid.
Regarding the granting of permits and administrative matters, the key market issues that could adversely affect incentives generally concern the legality and completeness of authorisation relating to the type of plant and its size, location and date of title release. This is because Italian legislation has proven to be complex and inconsistent. Since the 2001 constitutional reform, the responsibility for energy matters has been vested in the state and the regions. As a result, the regulatory framework for permits required to construct PV plants is different in each region. This has resulted in a series of regulatory mismatches rendering the applicable authorisation procedure uncertain due to:
- the cumbersome nature of the multi-level regulatory system;
- the tangle of administrative competences; and
- the increase in litigation between the state and the regions.
The principal market issues concern PV plants authorised through a simplified deemed consent procedure that have been built on adjoining plots of land. Since 2008, a number of regions have introduced guidelines to identify when applicants have sought separate authorisations for adjoining projects to build larger PV plants that needed to be authorised through more complex planning procedures. The regulation concerning subsidies for solar PV generation was amended in 2011 to consider these issues. The Fourth Conto Energia tariff regime introduced certain criteria that must be applied when calculating the capacity of PV plants in order to determine the applicable level of incentive. The aim is to prevent operators from splitting a single PV plant into multiple sites in order to benefit from an incentive that is higher than that applicable to the plant when considered as a whole. Finally, pursuant to the Ministerial Decree of June 23 2016, the GSE can consider a number of factors as indicators of malicious fractioning, including the fact that plants share the same grid connection infrastructure or electrical line.
Portfolios including PV plants subsidised under the Second Conto Energia tariff regime that have applied for incentives under the Salva Alcoa Law (another tariff regime) must be analysed with particular care. Some of the most serious issues concern:
- problems in the drafting of the project's certificate of completion;
- the absence of any notice of completion submitted to the grid operator and energy authority; or
- a lack of documentation demonstrating the plant's completion by December 31 2010 (eg, pictures showing the installation of modules, inverters and transformers, parts labelling and shipping documents).
The legal and technical due diligence process should also examine whether:
- a grid connection agreement is in place between the SPV and the competent grid operator;
- the export-import capacity is sufficient for the project's planned generation output;
- all connection costs have been paid;
- the grid connection work has been completed with no outstanding liabilities;
- the grid connection granted by the grid operator is not time limited; and
- the plant's date of entry into operation is compatible with its accreditation under the incentive regime granted by the GSE.
There may be also environmental risks. Various laws may require a current or previous owner, occupier or operator of a property to investigate or clean up hazardous or toxic substances or releases. These owners, occupiers or operators may also have to pay for property damage and investigation and clean-up costs incurred by other parties in connection with any such substances.
The standard set of representations and warranties provided by the seller in an SPA is expected to cover most of the above issues. Generally, there will be no liability on the seller's side if the relevant issue has been disclosed fairly. On the other hand, if the seller has been unable to provide access to a comprehensive suite of documentation, it would be prudent from the buyer's perspective for the due diligence exercise not to limit the seller's representations and warranties in the SPA and for the buyer to negotiate appropriate pro-sandbagging language in the SPA.
Depending on the due diligence's findings, alongside representations and warranties, buyers may also seek a purchase price reduction or special indemnity protections in the SPA. In general, it is important to ensure that monetary caps on the seller's liabilities allow sufficient compensation and that any time limit on the buyer's ability to claim under the indemnities allows sufficient time for the completion of surveys plus a few additional months to prepare the claim.
In this context, there is a trend towards requiring warranty and indemnity insurance, providing cover for breaches of warranties, covenants and indemnities given by the seller under an SPA. This insurance product seeks to bridge the gap between the buyer's wish for deal protection and the seller's desire for a clean exit. Advantages for buyers may include the duration of the coverage and the reduction of the risks of an insolvent seller. Warranty and indemnity insurance is designed to cover unexpected issues that arise after a deal has been completed; however, this assumes that the buyer has performed thorough due diligence of the target rather than relied on the policy (and that the seller has carried out a thorough disclosure exercise). Insurers will expect a balanced, negotiated SPA and a robust and complete due diligence exercise. Indications that the due diligence process has been skipped or rushed could lead to a high premium, thus lowering the scope of the coverage or denial of a policy entirely. Environmental issues, defects in the construction work and bribery and corruption are generally excluded from the scope of warranty and indemnity coverage.
It is not uncommon for sellers to seek earn-out provisions – for example, in the event that the competent authorities approve a repowering or grant a special subsidy in addition to the Conto Energia incentives (such as the Tremonti Ambientale tax allowance) after the closing date. While the approval of a repowering may be a win-win situation for both the buyer and seller, the feasibility and conditions for the simultaneous application of the Conto Energia incentives and other types of public subsidy should be prudently verified depending on the applicable Conto Energia.
Notwithstanding the issues identified above, there is a strong secondary market for Italian PV projects. This demonstrates that risks are manageable, provided that buyers undertake the appropriate level of due diligence and achieve adequate mitigation measures within the SPA.
For further information on this topic please contact Arturo Sferruzza or Ginevra Biadico at Norton Rose Fulbright Studio Legale by telephone (+39 02 8635 941) or email ([email protected] or [email protected]). The Norton Rose Fulbright Studio Legale website can be accessed at www.nortonrosefulbright.com.
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