Solar Energy System Design, Engineering, Construction, and Installation Agreements

The design and construction of facilities for the generation of electrical power from solar resources is an area that is filled with risk and opportunity. The goal of this chapter is to provide an overview of the legal issues encountered in the course of engineering and constructing utility-scale or distributed generation solar energy projects so as to identify key risk allocations that are commonly used in this sector to create the legal framework necessary for a successful solar energy project.

This overview is written from the perspective of a solar energy project owner/developer (for purposes of this chapter, the “owner”); however, this information may also interest design and engineering, construction, operations and maintenance, and financing entities as well. Further, the lines between owner, contractor, and equipment supplier are often blurred in the solar energy industry, as contractors and/or equipment suppliers often take on the role of developer (sometimes through joint ventures) and panel suppliers often perform the duties of the contractor. As with any complex negotiated transaction, there is significant value to be won or lost by all parties and the potential for creative legal strategies to enhance value for all parties.

I. Construction-Related Agreements. Critical to the development of any solar energy project are the various agreements a project owner must enter into for:

• Design and engineering of site improvements, adaptations, expansions or alterations of existing facilities and related infrastructure, electrical systems including interconnection facilities, and transmission and distribution systems;
• Procurement of power generation and energy storage equipment, such as photovoltaic (“PV”) panels, mounting racks, tracker systems, inverters, transformers, batteries, and collection systems;
• Construction management services necessary to successfully schedule, coordinate, and oversee the engineering, procurement, and construction of the power generation equipment and the balance-of-plant facilities; and
• Operation and maintenance of the completed facility.

Frequently, engineering, procurement, and construction tasks are combined within a single agreement called an Engineering, Procurement, and Construction agreement or “EPC agreement” or (if substantially all project tasks are assigned to a single entity) a “full-wrap” or “turnkey” agreement. The historic traditional development model for risk allocation is the design-bid-build method using the EPC agreement, versus the turnkey design-build package agreement that may offer a more palatable risk allocation to owners. It is also common to have separate agreements for procurement and installation of major power generation equipment supplemented by a “balance-of-plant” agreement for the construction of ancillary facilities. Solar facilities in the US are increasingly now installed with battery energy storage systems, which increases project complexity and introduces new project participants.

As an alternative to the single-entity EPC approach, the project developer may enter into separate agreements with a key equipment supplier, such as a PV module or battery energy storage system manufacturer, in order to secure favorable terms and a direct relationship with this key project player. The owner then provides the equipment to the contractor as “Owner-Furnished Equipment” under the EPC agreement. This may be desirable to some developers with large pipelines in order to secure favorable terms and a direct relationship with the supplier, and/or to lock in forward pricing and product volume for projects to be built in future years. This also limits “margin stacking” by EPC contractors, thus reducing overall project costs. Privity of contract with technology suppliers, such as battery energy storage system manufacturers, can also be desirable since at the end of the day only the original equipment manufacturer is going to agree to stand behind its technology (via its product warranties). If owner elects to procure major equipment directly, a key risk area is in matching up delivery, warranty, insurance, and project completion details from the equipment supply agreement with the terms of design, construction, and operation agreements with other contractors. It will be critical in such cases to coordinate each of these agreements to make sure that they collectively produce a complete project, and that the owner is aware of risk allocation and any risk gaps that will be borne by the owner.

Depending on the contractual structure, product or service warranties, insurance, and other matters may be addressed in the full-wrap agreement or may be addressed in individual agreements. Understanding how these issues impact and interrelate to each other is essential for creating a set of coordinated agreements.

II. Design and Engineering Services. Solar power projects require certain design and engineering expertise that is unique to this sector of the power generation industry. The designers and engineers must coordinate their services with the structural and electrical designers and engineers working on the structure to ensure proper integration and scheduling. Historically, relatively few companies designed, engineered, and manufactured solar energy generation equipment, PV or thin film panels, or solar thermal and concentrated solar units. Today there are a number of manufacturers in each of these areas.

With the growth and monetization of the industry and the maturation of incentives, new vendors are entering the market regularly. For several years, PV panel prices plummeted as manufacturing capacity increased worldwide. Currently, solar technology provides for various systems, from solar thermal hot water or concentration systems to silicon cell or PV or thin film generation panels. The needs and requirements for any particular project, however, are in part dictated by its operating parameters, which are in turn dictated by the project’s purpose, energy load, and location.

For instance, the weight tolerance of a rooftop installation may be different from the weight tolerance of a ground-mount installation, and the available mounting options will be different as well. These and other factors must be considered for proper project design and risk/opportunity assessment.

III. Construction and Installation Services. Solar systems are generally assembled from predesigned components that are aggregated and installed to suit the project’s needs. Nonetheless, substantial design and engineering work will typically be required to integrate the chosen system or systems into the existing environment, topography, and existing conditions at the project site, including the necessary interconnection requirements. These design and engineering services, and related procurement and construction work, may be performed by the supplier of the solar equipment and materials under one or more agreements, but are often provided by a third-party consulting engineer contracting directly with the owner or design-builder.

IV. Typical Contractual Structure for a Distributed Generation Solar Project. Given the multiple factors influencing the development of a distributed generation solar energy project, no single contractual structure applies to all projects. However, the following example of a contractual structure used for a particular distributed generation solar project illustrates, in a limited way, how a project owner, its design-builder or general contractor and prime architect, and a solar equipment supplier might address certain common concerns. Many of the concepts discussed below also apply to utility-scale solar projects.

In this example, a project owner wants to install a PV system on a building to provide a portion of its electrical needs. The owner wants to have the same entity design, install, test, and commission the system, as well as construct the electrical interconnection facilities and ensure a minimum yearly electrical output. The owner also wants to make sure it can enforce any warranties provided by third-party subcontractors and suppliers of materials and equipment, and wants liquidated damages for any delays that might affect the project and undermine the owner’s expectation regarding the project’s ability to claim tax credits and incentives for the system under state and federal regulations.

The project owner and the solar contractor may enter into a solar installation agreement whereby the contractor agrees to design, install, test, and commission a PV electric generating system, including necessary interconnection facilities, on the project site.

Under the agreement, the owner has the right to review all subcontracts for equipment, design, and installation services entered into by the contractor, and any such subcontracts are required to contain certain provisions for the benefit of the owner. The agreement also provides for delay liquidated damages, whether or not tax credits or incentives are lost due to the delay. Finally, due to the electrical integration element of such a project, the agreement provides that final completion (whereby final payment is due to the contractor) is conditioned on approval of the project by the local utility and receipt of all appropriate electrical inspection certificates.

The slate of issues that the parties address in the installation agreement includes the scope of work, inspections and testing, liens, change orders, measures of completion, liquidated damages, rebates and subsidies, system and work warranty obligations, coordination of activities, permitting reports, title and risk of loss, energy guarantees, and indemnification and limitations of liability.

A. Scope of Work. In the example above, the parties placed great emphasis on the description of the scope of work/statement of work (or “SOW”) set forth in the installation agreement. In general, except in true turnkey projects based solely on performance specifications, the parties’ scope-of-work provisions should describe, in detail, the actual design, engineering, and construction obligations of the contracting parties, as well as their coordination with other service providers on the project. The scope of work should incorporate the system’s performance and design specifications by reference to either an attached annex or a specific set of separately prepared plans and specifications. Generally, whatever is not provided for in the contractor’s scope of work is the project owner’s responsibility to complete or to contract with third parties to complete. A solar energy system contractor’s scope of work typically includes the design and engineering of the system, including its principal parts and components, as well as certain obligations relating to commissioning and performance testing of the major components of the system, and related warranty work. The contractor’s scope of work may include providing operations and maintenance services for a set number of years after completion of the system. These services are often the subject of a separate agreement. As with other aspects of such an agreement, the scope-of-work provisions will probably be heavily negotiated. Care must be taken to coordinate the scope of services being provided by the contractor with the scope and timing of services being provided by third parties on the project to minimize conflicts or gaps.

B. Measures of Completion and Start-up Obligations. The scope-of-work provisions of the relevant agreements typically determine who will be responsible for facility start-up and commissioning and when and how such activities will be accomplished. Given a solar system supplier’s in-depth knowledge of its products, the supplier (or its design subcontractor) will, at a minimum, supervise system start-up and may also be engaged to commission and optimize the products and systems it supplies. However, this work can also be undertaken by the project owner (with assistance from the supplier) or by a third party contracting directly with the project owner. In any case, the relevant agreements must address the stages of completion, such as actual delivery of the equipment to the project site, followed by installation, start-up, and testing. Once these progress milestones are established, completion is generally evidenced by certifications of, for example, “mechanical completion,” “substantial completion,” “placed in service” (or “commercial operation”), and “final completion/final acceptance.” Each such certification is considered an incremental measure that the project must satisfy in order to progress to the next measure.

In general terms, mechanical completion is the stage where the facility is mechanically and electrically complete and capable of safe operation in accordance with the contract, applicable law, and applicable permits, but for minor defects and omissions that do not prevent commercial operation of the facility. At mechanical completion, however, the facility is not interconnected. In order to achieve substantial completion, the facility must achieve mechanical completion and then be commissioned, tested, and fully interconnected. Substantial completion is almost always a guaranteed date that the contractor must meet, or else the contractor will be liable to the owner for delay liquidated damages (typically at an agreed daily rate tied to the capacity of the facility). Increasingly, owners and their financiers require the contractor to also guarantee the mechanical completion date, with associated delay liquidated damages at a rate that is less than or equal to the rate for a failure to achieve substantial completion by the guaranteed substantial completion date. This trend started because mechanical completion is typically a key upstream milestone for tax equity financing purposes. Where delay liquidated damages attach to the mechanical completion milestone, contractors sometimes negotiate a refund or credit for such delay liquidated damages in circumstances where the contractors are able to achieve substantial completion by the guaranteed substantial completion date notwithstanding their failure to timely achieve mechanical completion.

As with other supply and construction-related agreements, progress payments by the project owner to the supplier/contractor (as set forth in the relevant agreement) will be based, in part, on the milestones described above. For instance, the owner typically pays a certain amount toward the agreed-on contract price (1) upon contract execution, (2) when the purchase order for major equipment is submitted, (3) upon the delivery of the major equipment to the project site, (4) upon mechanical completion, (5) upon substantial completion (after successful testing and commissioning and payment of any delay or performance damages), and (6) upon final acceptance/completion, after the contractor completes all items on the punch list. Alternatively, the payment schedule can be based on monthly applications for payment based on expenses and labor incurred or work performed in the foregoing period, with a percentage holdback or retention amount (for possible repairs, claims, or liens) to be released at substantial completion, subject to a punch-list holdback.

C. Warranty Obligations. The nature and scope of an EPC contractor’s warranties will depend on the scope of services, materials, and equipment the contractor provides. An equipment supplier’s warranties generally warrant defects in design, material, and workmanship in the product for a set number of years from delivery or commissioning of that product. For a contractor providing only installation services and materials, the warranties are generally limited in scope relative to those of an equipment supplier, but would still include warranties relating to workmanship, minor parts, and materials used in installation and any engineering services provided. The definition of a defect can be important when determining what is included or excluded as a defective or nonconforming part or component in a solar facility. If both equipment and installation services are provided by the same contractor, or through subcontractors, it is important to ensure that all subcontractor and supplier warranties that exceed the contractor’s warranty period are assigned or transferred to the owner.

The issues that contracting parties consider in respect of warranties include (1) the period or term of a particular warranty and whether the term can be extended (it is common for a supplier to offer certain extended warranty services at an additional cost to the owner), (2) the definition of a defect and a serial defect (where multiple equipment components of the same type fail in excess of an agreed threshold during the warranty term, thus triggering a root cause analysis and remediation plan for that component), (3) limitations on warranty arising from acts of third parties such as operation and maintenance contractors or the system operator and other exclusions, such as force majeure events, and (4) the remedial measures a contractor must take to repair or cure any defect, including response times. It is also important to specify with a contracting party minimum warranty terms that must be negotiated into third-party agreements.

D. Performance Guarantees. Performance guarantees are likely to be an issue of substantial negotiation between parties to solar EPC agreements. The issues that the parties should consider relating to performance guarantees include (1) the appropriate measurements of performance for project components and for the fully assembled system; (2) timing of performance testing, required external testing conditions, and responsibilities for administering the tests; and (3) the consequences if performance testing is not successful. Performance guarantees for solar facilities are often dictated by the corresponding guarantees the owner must give under an offtake agreement, such as a power purchase agreement or energy storage capacity contract.

Typical performance guarantees for solar projects include output/capacity guarantees and performance ratios guarantees. These performance guarantees are designed to ensure that the solar facility can generate and discharge the contracted amount of energy over a specified time (e.g., 30 to 90 days or even for the first year of commercial operation). If the facility includes an energy storage system, an additional set of performance specifications, tests, and guarantees will apply to that system.

It is important to consider which party is best positioned to give the performance guarantees based on the SOWs in the various contracts. In most cases the EPC contractor will give such guarantees in relation to the solar facility, subject to carve-outs for defective Owner-Furnished Equipment and other third-party acts and omissions. (On the other hand, the owner will likely need to look to the battery integrator or original equipment manufacturer to guarantee battery system performance.) The EPC contract may have a minimum guaranteed value for each metric and allow for a cure period if the guaranteed value is not achieved after testing. Either delay liquidated damages or performance liquidated damages may attach to a failure to achieve this value by the relevant milestone date or expiration of any cure period. Alternatively, the contract may require a one-time “plant buy-down” payment to be made by the contractor to the owner if the facility is capable of commercial operation but does not achieve the performance guarantees upon completion to compensate the owner for contractor delivering a facility that fails to perform at the contracted capacity or capability.

E. Limitation of Liability. Like other contractors and vendors, solar project suppliers and contractors will seek to limit their liability to a project owner. A common request is for a waiver of consequential, indirect, incidental, and special damages. Such clauses should be negotiated carefully because what qualifies as a “consequential” as opposed to a “direct” damage may be unclear. A project owner’s waiver of consequential damages may present potentially substantial loss exposure to the extent that the project owner fails to achieve certain incentives (e.g., tax credits) or performance objectives as a result of the contractor’s failure to perform under the contract. The project owner may attempt to mitigate such exposure through liquidated damages for delay and performance shortfalls. A contractor may also seek to limit its liability for delay or performance through individual and aggregate caps on liquidated damages, usually at an agreed-on percentage of the contract price. Liability caps and other limitations of liability generally have express exclusions, including obligations to indemnify against third-party claims and fraud, gross negligence, and willful misconduct. Liability caps and exclusions can be sensitive areas for the parties, subject to corporate policies, and commonly require substantial negotiation.

F. Solar Tax Credits. The economics of a solar energy system and the overall project budget often depend on obtaining certain benefits provided under state and federal law for renewable energy projects, including the federal solar investment tax credit (“ITC”). The loss of the ITC, or of similar state and federal benefits, can be very serious because the benefit, once lost, may never again apply to the project (unlike damages for failure to achieve an operational status for purposes of net metering, which may be limited to the actual period of delay), and thus could have long-term economic consequences. ITC-related damages are usually the subject of much negotiation between the supplier or contractor and the owner. Insurance coverage may be available for certain delay-related risks, including failure to qualify for the ITC.

V. Other Issues.

A. Project Financing. A solar project owner often requires some form of substantial debt or equity financing to pay for the design, engineering, procurement, construction, and initial operations of the project. Financial institutions and potential investors will demand the opportunity to review and comment on a project’s design and EPC agreements (as well as related equipment supply, operations and maintenance and warranty agreements, if separate) before committing funds. Of special interest to prospective lenders and investors are the provisions in the agreements that provide the lender or investor with the ability to take over the project if the project owner (the borrower) defaults, and the provisions that specify the extent and nature of any damages available to a project owner from a contractor for late completion or failure of the project to generate expected amounts of power. Also, financial institutions will want to comment on the payment plans and security, warranty, and inspection provisions set forth in the project agreements.

Due to such involvement, and to avoid issues arising from any potential inconsistencies, the project owner should be prepared to present a consistent and cogent set of project agreements to lenders and investors, and to listen to their suggestions for such agreements. Further, the owner should be prepared for the possibility that lenders and investors may want to make substantial changes in the negotiated agreements. For instance, lenders will often be interested in the project’s financial and operational viability (as may be reflected in a feasibility study), and much of that interest will necessarily focus on the project owner’s rights under the relevant agreements. In particular, lenders will be interested in the extent, limitation, and operation of any contractor warranties, contractor indemnities, insurance policies, progress or performance-test milestones and payments, and performance and payment guarantees. Lenders will also want to know whether the various agreements are entered into on an “arm’s-length” basis, meaning (among other things) that the terms and conditions of such agreements are based on typical commercial terms and standards. It is important to include typical financing cooperation provisions in the project construction agreements, including allowing the agreements to be amended as reasonably requested by lenders and investors. Contractors are likely to seek to limit this right by, among other things, including a limitation that such revisions cannot meaningfully increase the contractor’s obligations or increase its costs to construct the project.

B. Performance and Payment Bonds. A project owner should cause the various contractors to procure, for the benefit of the owner, performance and payment bonds (or other forms of credit support, such as letters of credit) to secure the obligations of the various contractors (whether engineers, contractors, or other parties) to complete their work on time and in accordance with the requirements of their various agreements, and to protect against liens and claims from unpaid contractors and subcontractors. Typical bonds are described below.

• Performance Bond. A performance bond is usually issued by a bank, insurer, or bonding company, and is selected or approved by the project owner, and states an agreed-on “penal sum,” often the full value of the project. This sum is payable upon the owner’s demand in the event that the contractor fails to perform its contractual obligations in a proper and timely manner. For instance, when the contractor defaults or cannot complete the project, the owner may call on this bond to pay another contractor to complete the project. The owner will want to reserve its other rights against a defaulting contractor in the event that the performance bond does not fully cover the owner’s costs of completing the project or costs associated with damages the owner may owe to a third party as a result of any default by the owner. While terms of the bond are often presented by the surety as “standard,” they are still somewhat negotiable to ensure that the owner is protected sufficiently. The bond obligations should be coordinated with the obligations of the EPC or turnkey agreement (i) to ensure that the project owner’s compliance with the notice and default obligations under the EPC agreement will satisfy the requirements under the bond and (ii) to avoid unintended conflicts or preclusion of the project owner’s ability to recover under the bond.
• Payment Bond. A payment bond is intended to ensure that if the contractor fails to pay its subcontractors and suppliers following receipt of payment from the owner, then such subcontractors and suppliers will be paid, often without the necessity of filing liens or other security interests against the project owner’s property. If a lien claim is asserted, it may be “bonded-over” so that it attaches to the payment bond or other security instead of the property. Lenders, upon their review of the agreements, may demand or require payment bonds or other guarantees (including subordination agreements where not prohibited by state law) to enhance their security interests in the project. Methods of substituting bonds for lien claims vary from state to state, so careful attention to the laws of the project state is important.

The project owner or the lenders may require other security from contractors, such as parent guarantees, standby letters of credit, and other forms of assurance. The contractors will seek ample opportunity to cure any default or delay, and will try to limit the project owner’s ability to call on performance or payment bonds or other security without clear proof of a failure of performance by the contractor. In turn, contractors may demand some form of reciprocal security issued by the owner or its parent company, including parent guarantees, payment guarantees, and the like, particularly if the owner is a special purpose project company, such that its only substantial asset is the project itself.

C. Lien Release Issues. When the project owner makes periodic payments to contractors (and thus also to subcontractors and suppliers), the owner should obtain lien and claim releases to the fullest extent permitted by applicable law. Many states require the use of specific statutory forms of lien releases on a conditional or unconditional basis for interim and final payments. A lien release will help protect the owner from liens being filed on the project by lower-tier subcontractors and suppliers that have such rights if they have not been paid, and avoiding the possibility of the project owner paying twice for the same work or materials. Additionally, such liens are undesirable because, once filed, they can delay or interfere with the project’s financing or sale. They also generate litigation, in which a successful lien claimant in a lien foreclosure action is often entitled to recover its attorneys’ fees, costs, and interest in addition to the contractual amount due. Worse still, if a lien claimant is successful in prosecuting its lien claim to foreclosure, such a lien could be used to force the sale of the project, or part of it, which would further interfere with the project owner’s plans for the sale or refinancing of the project. Many financing agreements will also consider a lien to be a breach of the agreement.

D. Insurance and Indemnity Issues. A project owner should obtain appropriate indemnities and insurance coverage from the various parties with which it contracts, should require those parties to obtain similar protections from their subcontractors and material suppliers for the benefit of the owner, and should verify compliance with such requirements. Relevant indemnities include a general indemnity for personal injury, death, and property damage claims, contractor and subcontractor lien indemnities, an indemnity for taxes (other than those payable to the owner), an indemnity for violation of applicable laws, and an indemnity for intellectual property infringement claims. Appropriate insurance policies include commercial general liability, workers’ compensation and employer’s liability, automobile, errors and omissions (for design and engineering services), and builder’s all-risk (property insurance for the project improvements). Such policies should name the owner and its financing parties as additional insureds and contain appropriate waivers of subrogation. Appropriate policy limits will vary with respect to the nature of the work being performed and the scope of the project. It is advisable for an owner to consult with an insurance or risk management specialist to ensure that appropriate types and levels of coverage are obtained.

VI. Build Transfer Arrangements. The procurement, design and construction arrangements described above are also combined with an acquisition agreement for certain larger scale projects and generally where an electric utility will be the ultimate owner. In many of these cases, the developer owns the project assets and manages the construction process to the utility’s particular specifications. Generally, the developer maintains ownership until mechanical completion, after which closing on the acquisition occurs and title to the project assets transfers to the utility. Though the utility takes title at mechanical completion, the contractor continues to manage the testing and commissioning process and the remaining work to reach final completion. Contractual negotiations for such build transfer agreements are often an exercise in reducing as much uncertainty as possible by the time construction commences to minimize the utility’s offramps, termination rights and ability to avoid closing under the agreement after significant procurement and construction costs have been expended. Another arrangement, which may alleviate at least the post-construction closing risk, transfers ownership to the utility prior to commencement of construction under a separate purchase agreement and then arranges for notice to proceed to be simultaneously issued under a related turnkey EPC agreement pursuant to which the developer constructs the project for the new utility owner. In either case, great care needs to be taken with respect to allocating price and schedule risk and to make sure construction and technical specifications included in the build transfer agreement are reasonably obtainable and reasonably align with the developer’s subcontracts for various related pieces of the work.

VII. Current Developments. Over the last decade solar energy has grown exponentially from a start-up-based niche market to what is now recognized as a key sector within the electrical power generation market. During that time, the cost of solar energy dropped at a faster rate than that of any other form of energy. The cost to build solar facilities rose this year for the first time in many years due to inflationary pressure on shipping costs, raw materials, and equipment manufacturing, as well as upward price pressure on imported PV modules due in part to US trade and human rights policy. Notwithstanding these short-term challenges, solar development costs remain near all-time lows and the levelized cost of solar energy remains highly competitive with most other forms of generation. Stoel Rives has been at the forefront of many of the groundbreaking PV projects at utility and commercial scale, and we look forward to providing leadership in providing innovative and appropriate legal solutions to build this important sector of the renewable energy industry through successful projects for all concerned.