Developer fees are receiving more scrutiny from the Treasury in applications for section 1603 payments for renewable energy projects.

The term “developer fee” is often misused. The classic developer fee is a success fee that a project company pays a separate development company as a reward for pushing the project across the finish line. The Treasury is generally limiting such fees paid to affiliated development companies to 3% to 5% of the project cost. Exceptions are where a development services agreement was in place before 2009 or development took an unusually long time and the developer had a lot of capital at risk.

People frequently misuse “developer fee” to refer also to a gain on sale of a project after construction. For example, a developer who sells and leases back his project may have a gain on sale. The Treasury is generally limiting the mark up it will allow in cases where a project is sold to a third party, including in a tax equity transaction, to 10% to 20% above cost.

The term “developer fee” is sometimes also used to refer to a cash distribution by a project company to its owner. Most project companies are limited liability companies. They are usually treated as partnerships if they have at least two owners or are ignored — “disregarded” — if there is a single owner. A cash distribution by a project company treated as a partnership to a partner does not usually add to basis. A cash distribution by a disregarded project company to its sole owner does not add to basis either.

September 30 Deadline

All remaining cash grant applications must be filed with the Treasury by September 30, 2012. Congress wanted Treasury to have a sense by September 30 for how many remaining claims there may be on the program.

In cases where a project is not yet in service, a preliminary application must be filed demonstrating that the project was under construction by December 2011, and then a final application must be filed within 90 days after the project is put in service. The only projects that still qualify for section 1603 payments, or cash grants, are projects that were under construction by the end of last year.

The Treasury has been responding by email to preliminary grant applications acknowledging that the requirement to file has been met, but reserving the right to question later whether construction started in time.

Many solar rooftop companies took delivery of panels or inverters late last year and will be considered to have started construction of future rooftop installations that use this equipment, provided the stockpiled equipment used amounts to more than 5% of the basis ultimately used to calculate the cash grant on the installation.

The Treasury is taking the position that a separate application must be submitted for each future project or rooftop system. The Treasury does not need to know by September 30 the customer name or location of each project. However, it does need to know the particular equipment that will be dedicated to each project.

Suppose a company stockpiled 100X of solar panels in 2011. It can divide up the panels for use in separate projects however it wishes. It would then submit a separate application for each batch of equipment. The Treasury will assign a separate TAN or tracking number to each equipment batch. It will then want to match that number to the eventual project built.

The company cannot later combine equipment to reach the 5% threshold for a single project. For example, suppose it submits 20 separate grant applications for batches of 5X panels each and the 5X panels cost $10,000. It will only be able to claim cash grants on projects using these panels that have a basis for grant purposes of less than $200,000 ($10,000 ÷ 0.05).

It does not need to identify the serial numbers of the particular equipment assigned to each preliminary grant application. It is enough to say project 1 will use 5X of the stockpiled panels without identifying the location of the project or customer or the specific panels by serial number.

There is a risk, if a company installs a rooftop system using two batches of stockpiled equipment, that the Treasury will say the installation is a single project and does not qualify for a grant. Suppose each grant application submitted covers two panels and one inverter. The company installs a system using four panels and two inverters and reports it as two separate systems. There is a risk that the Treasury will say the installation is a single project.

Lawsuits

Three suits against the Treasury cash grant program are pending in the US Court of Federal Claims.

The government’s frustration against a solar company that filed one of the suits has now led to charges that the solar company tried to defraud the government.

Pure Power Development filed suit in February 2010 seeking $2.33 million in grants that it says it was denied on 25 mobile solar systems that were mounted on the backs of flatbed trucks. According to documents filed in the case, the company bought the systems from the manufacturer for $4.30 to $5.80 a watt for regular systems and for as much as $6.80 a watt for “super” systems, resold them to affiliated companies for $19.45 to $26.24 a watt for regular systems and as much as $45.50 a watt for super systems and claimed cash grants on the resale price. The company produced an appraisal suggesting the high resale price was the market value. The price was not actually paid: Pure Power Development took back notes from the buyers for the price. The National Renewable Energy Laboratory staff who reviewed the grant applications did not believe the systems were ever put into service. The government says the company made direct cash sales to third parties at lower prices during the same period.

NREL recommended to Treasury officials in Washington that the government pay much lower grants or no grants at all. Its report said, “the Treasury 1603 Review Team has pointedly asked [the applicant] to provide a rational cost basis for their property and has suggested the cost basis should be less than $50,000. Despite this, [the applicant] has worked even harder to justify the cost basis to Treasury.”

The government asked the court last year for a “summary judgment” in its favor on grounds that the government has discretion whether to pay grants. The court declined. It said the Treasury is required to pay a grant to anyone who satisfies the eligibility requirements in the statute.

The government amended its response in the case in July to accuse the solar company of trying to defraud the government. It says the company should forfeit any right the company has to grants on the systems and pay damages. Two other suits have been filed against Treasury this year. Clean Fuel, LLC filed suit in February 2012 after being denied grants on Cummins generators that it added at two existing biodiesel plants in Florida. The plants make biodiesel from waste soy, palm nuts and some waste animal fats. Clean Fuel bought them in early 2009 from the original owner and added the generators a year later to make electricity for use in the plants. Treasury appears to have denied grants on grounds that the company was asking for grants on used property. The company would not have qualified for production tax credits on the electricity because there is no sale of the electricity to third parties. However, the Treasury does not appear to have raised this as a bar to a grant.

The third suit was filed in May by a small electrical contractor, RCIAC, in Dallas that installs solar rooftop systems on homes and businesses. The contractor feels it was shortchanged on the grants it was paid on 18 systems. Each grant was roughly 85% of the amount claimed. (One grant was 77%). The contractor set up a separate partnership called LCM Energy Solutions of which the company sales head was listed as CEO that bought the systems, after installation from RCIAC, and then leased them to customers.

Bankruptcy

The Treasury plans to try to get back all or part of a $6.5 million cash grant that it paid the Thompson River project in Montana. The project is a coal-fired power plant that the owners converted to run on wood. However, it is not clear whether the plant ever operated after the conversion, according to published reports. The owner is now in a chapter 7 bankruptcy proceeding in which the business will be liquidated. A bankruptcy filing alone does not lead to recapture of a grant. However, recapture would be required if the plant never operated or is permanently removed from service as a wood-fired power plant. Any claim by the government would be as an unsecured creditor.

At least two other prominent grant recipients have also filed for bankruptcy: Raser Technologies, a geothermal developer, and Sterling Energy Systems, Inc., a solar developer.