Project Finance for Wind Power Projects

I. Introduction. The universe of wind power project financing has seen a steady evolution over the past two decades. When the industry first began to see large “utility-scale” wind projects 20 years ago, early-stage development typically included equity provided by the developer and its owners/investors. But as development companies pursue larger, more expensive projects, the reliance on the owners/investors has often proven inadequate to provide the needed development capital. At the same time, competition for “shovel-ready” projects has increased, a trend that has accelerated as owners/operators have sought to acquire projects that can be “grandfathered” to qualify for the maximum amount of U.S. production tax credits (“PTCs”) available as the subsidy currently is scheduled to step down in the coming years. As a result, developers increasingly have entered into arrangements where a well-heeled strategic investor provides a portion of the needed capital that, together with debt financing, enables the developer to proceed with project development while offering the strategic investor a first call on the project.

For wind projects ready to be built, financing continues to consist of tax equity partnerships, cash equity investments, and debt financing (most frequently through back-leverage debt). While the basic financing structures are all similar, the details can vary significantly depending on the particulars of the project, the requirements and concerns of the investors, and the state of the market at the time.

The wind industry has seen marked consolidation over the past 10 to 12 years. While many windy places remain effectively untapped by the industry, most of the locations closest to load and existing transmission capacity and with the fewest significant environmental concerns have been developed. As a result, the days of “two guys in a pickup” out developing wind projects are largely gone, being replaced by arrangements between developers and strategic investors as referenced above. The number of strategic investors willing and able to assume the development and construction risk and bring new, large-scale wind projects to market has remained fairly constant, while the number of tax equity and cash equity investors has increased significantly since the depth of the 2008-2012 recession. Niche markets remain for smaller-scale (30-80 MW) projects in certain parts of the United States, but the lender and investor profiles for those projects can vary in meaningful ways from the lenders and investors in larger-scale (100-300+ MW) projects. Today, only the most sophisticated developers and owners/operators with access to a substantial balance sheet can expect to survive through to permanent financing.

Financing can be seen as the epicenter of wind project development. In order to weather the storms of investor and lender due diligence, all aspects of a project must be aligned, such that the result is a fully functioning, revenue-generating, and legally permitted project returning sufficient value to justify putting investor and lender dollars at risk. Accordingly, a wind project finance deal is not merely a negotiation of financial terms, but rather necessarily involves an analysis of real property rights, construction and development contracts, equipment warranties, power purchase and other offtake agreements like financial hedges, swaps and contracts for differences (whether with a utility or a commercial/industrial offtaker), interconnection rights, environmental permitting, and (of course) tax issues.

Tax issues, in particular, have dominated negotiations of wind project financing since the latest phase down of the PTC was implemented in the wake of Congress’s sweeping tax reform package in 2017, artfully titled the “Tax Cuts and Jobs Act.”

II. Project Finance Basics.

A. Risk Shifting. The golden rule of project finance is one of risk mitigation: the deal structure must allocate risks that could affect the project’s cash flow or assets to creditworthy parties that have the ability to mitigate those risks. Much of the drama in putting together wind energy project financing will derive from each participant’s efforts to shift various risks to others while retaining the particular benefits that the participant seeks from the transaction. The project owner will seek to shift technology risks to the equipment manufacturer and construction contractor while preserving for itself as much of the cash flow and appreciation in project value as possible. The lender will seek to shift risk to the project owner by taking first positions in the project revenues and assets, and securing direct rights to the warranties and contractual obligations of third parties such as the equipment manufacturer and construction contractor, all to enhance the prospect of the loan being repaid on schedule. The tax equity investor, as well as any passive cash equity investor, will aim to push all project-specific risks onto the sponsor through broad representations and warranties that are backed by indemnification obligations supported by parent guaranties and cash sweeps (or holdbacks) of the sponsor’s distributable cash.

The risks at issue in a project financing can be classified in many ways, but broadly speaking the major categories of risk include the following:

1. Development Risk – What is the likelihood that project assets like real property rights, interconnection queue positions and upgrades, transmission capacity, and environmental permits can be obtained in a manner (and on a timeframe and at a cost) that can justify initiating negotiations of engineering, procurement, and construction (“EPC”), balance of plant, and turbine supply agreements?
2. Construction Risk – What is the likelihood that the project will reach commercial operation without running overbudget or behind schedule, encountering insurmountable construction issues, or defaulting on guaranteed commercial operation dates in its offtake contracts? If supply chains are constrained or sponsors are in a rush to commission projects in time to qualify for the maximum percentage of PTC available, construction risk becomes more acute.
3. Technology Risk – Will the technology incorporated into the project, including turbine blades and nacelles, transformers, supervisory control and data acquisition systems, and environmental monitoring and mitigation equipment, perform as intended and has each been tested and proven? Recently, technology risk is of particular interest to sponsors, investors, and lenders in the offshore wind space.
4. Counterparty Risk – Will each project participant remain solvent and creditworthy and capable of performing its particular contractual obligations when required, such as the EPC contractor’s capacity to make good on warranty claims? Recently, counterparty risk also has included intellectual property risk, e.g., the risk that a supplier becomes subject to sanctions for patent infringement imposed by the International Trade Commission.
5. Revenue Risk – This is a specific species of counterparty risk focusing on the offtaker’s capacity to pay for the power generated by the project over the term of the offtake agreement or to pay the incremental difference over the market price in the case of a financial contract for differences or a financial hedge or swap (which is especially relevant with respect to commercial and industrial customers, in contrast to utilities). If the “offtake” is actually a contract for differences or a financial hedge or swap that depends on hub and node prices in a liquid market, then a third-party pricing forecast is critical to assessing the revenue risk for both the “offtaker” and the sponsor.
6. Operational Risk – Wind is an intermittent resource, so a critical question is whether the project can achieve the level of performance and power output that was forecast in the project’s engineering and design plans, and what other factors (such as weather) can degrade this performance. No wind means no electricity, and no electricity means no revenues to pay project operating expenses and debt and to provide a return to the owner. And even with sufficient wind, particular attention must be paid to the ability to deliver the energy to load in the face of potential transmission constraints. In recent years, certain tax equity investors have insisted on production “haircuts”—i.e., financially modeled reductions in expected project output—based on their own experience in particular markets or with certain technologies.
7. Political Risk – This refers to the risk of governmental action interfering with the project, ranging from denial of discretionary permits and approvals to exercise of eminent domain authority. Political risk can also take the form of changes in law that adversely impact a project, whether during development, construction, or operation. One recent example is Senate Bill 3, passed by the Texas legislature in the wake of Winter Storm Uri in 2021, pursuant to which the Public Utility Commission of Texas formally adopted new winter weatherization requirements for all power generators and initiated a review of the design of the wholesale electric market operated by the Electric Reliability Council of Texas or ERCOT. Outside the United States, the potential for outright nationalization of projects should also be considered.

This risk shifting is accomplished by various legal undertakings by the participants: mortgages and security interests granted in the project assets, revenues, and key project agreements; warranties and contractual requirements for the equipment and the work performed in making it operational; various types of insurance to cover certain adverse events; guaranties of each participant’s obligations from creditworthy entities; and (of course) good old-fashioned indemnification (whether capped or uncapped, and whether backed in full or in part by a parent guarantee or not). The negotiation and documentation of these risk-shifting devices is the focus of activity in project financing, resulting in equity, tax equity, and loan documentation of substantial heft and complexity.

B. SPVs, Portfolios, and Recourse. In nearly all instances, the assets for a particular project are housed in a single special purpose vehicle (“SPV”) that is a separate legal entity from the ultimate upstream owner of the project and generally a limited liability company (“LLC”). This means that legal title to any project real estate interests (whether outright ownership, leasehold interests, or otherwise) should be in the name of the SPV, and the SPV (and not any upstream entity) should have its name on all project contracts. The SPV is commonly referred to as “the project company.” Putting all assets into an SPV is a simple step but has significant implications for the ability to sell, buy, and finance a project.

Purchasing the equity interests of the SPV is almost always a simpler proposition than assigning (and obtaining all necessary consents to assign) title to each asset individually in an asset purchase agreement. In a secured financing, a lender will want the parent company of the SPV to pledge the equity interests in the SPV as collateral, in addition to the pledge of project assets, to provide a simpler route to foreclosure in the case of a default.

In a portfolio financing, multiple projects can be financed together by transferring ownership of multiple project SPVs to the same holding company (provided such structure is permitted by each SPV’s power purchase agreement (“PPA”) and other project contracts), and investors can view each SPV’s equity interests as a separate cash flow stream. If the portfolio financing involves a tax equity investment, the structure will often require that SPV ownership be transferred to the tax equity partnership only once a project has achieved commercial operation pursuant to the terms of its PPA in order to avoid shifting construction risk to the tax equity investor (although that is not always the case). Portfolio financing in essence allows an investor to diversify its risk among multiple different assets through a single point of investment. In this scenario, the effect of one project’s default on another project becomes a prominent question. Where the effect of a financing agreement default by one SPV also creates a default for a second “sister” SPV, the projects are said to cross-default. If the default by a project is self-contained and does not permit the investor to take enhanced action against other projects in the portfolio, there is no cross-default.

Cash equity financings also often utilize a holding company to serve as the financing vehicle. In such cases, the project sponsor and the cash equity investor form a holding company that owns the non-tax equity interests in the project company (or in the holding company that owns a portfolio of projects, if a holding company structure is used at the tax equity level). Use of such an upper-tier holding company enables the sponsor and the cash equity investor to adjust their business relationship to suit their particular needs and largely removes these issues from discussion at the tax equity level.

In addition to facilitating transactional flexibility, the use of SPVs also permits another central distinction to be made in project financing: that of “recourse” versus “non-recourse” financing in debt deals (the concept of recourse does not apply in equity and tax equity transactions because the investors are owners of the SPVs in question, whether directly or indirectly).

1. Full Recourse (Balance Sheet) Financing. If the financing provider has a claim against the balance sheet of the project sponsor/owner to support repayment of the debt, then the debt is said to be “full recourse” to the sponsor. It is “full” recourse in that the lender can enforce payment of the debt out of any and all unencumbered assets of the entity providing the balance sheet support to underwrite the risk that the debt will not be repaid. Balance sheet financing is usually unsecured, with the lender taking no lien on or security interest in any tangible or intangible assets of the borrower.

Balance sheet financing is generally only available to the more substantial players in the electric industry, e.g., investor-owned utilities, power marketers, turbine manufacturers, and others whose long-term unsecured debt is rated at least investment grade by one of the national ratings agencies.¹ With balance sheet financing, the focus is on the financial position and prospects of the entity providing the balance sheet, rather than on the legal, economic, and technical viability of the wind project itself. Whether the project will be successful is less of a concern than if the success of the project was the only route to repayment of the debt.

It is important to note that even substantial players in the industry with the capacity to back their debt with a balance sheet choose not to do so. Why? Opportunity cost. The more a company’s balance sheet is used to support debt for one or more projects, the less it will be available for other corporate purposes like the acquisition of other companies or the maintenance of a balance-sheet debt posture that will not adversely affect the company’s stock price. The alternative is “non-recourse” or “limited recourse” financing.

2. Limited Recourse (Project) Financing. If the financing provider has recourse only to the assets comprising the project in question, and not to the sponsor’s assets generally, then the debt is said to be “non-recourse” or “limited recourse.” (To be clear, the term is always meant as “full recourse” or “non-recourse” as to the sponsor. Even “non-recourse” claims of a lender still have recourse (1) to the project for loans made directly to the project company SPV and (2) to sponsor’s interests in the project SPV for back-leverage loans.² ) The financing provider’s remedies in non-recourse financing are fundamentally limited to the value of the project itself, and in a worst-case scenario, the sponsor could have all the value of the project taken from it through foreclosure, sale of the project, diversion of the project cash flow stream, equity dilution, or other remedy. While project debt financing generally means non-recourse financing, many deals will include specifically negotiated parent guaranties for various perceived risks and other credit support or capital contribution obligations that blur the lines of the non-recourse structure.

C. Milestone Terminology. The risks placed upon, and the benefits available to, investors in wind project financings will vary depending upon the specific stage of a project’s development at the time of the financing. The exact timing of an investor’s funding often hinges on a project’s achievement of certain development milestones, with the financing documents plugging into concepts defined in other project contracts, the U.S. tax code and Treasury Regulations, or other sources. It is therefore useful to define a few key development-related concepts and acronyms before proceeding:

• “Notice to Proceed” or “NTP” refers to the formal directive given to the EPC contractor to commence full-scale construction and purchasing work. The issuance of NTP generally requires making a large mobilization payment to the EPC contractor and is usually the first point in the construction process at which a large sum must be funded (initial payments in connection with the turbine supply agreement will most often have been made prior to NTP, but sometimes those payments will be made concurrently with NTP). In some cases, sponsors will leverage their balance sheets to fund the NTP payments. In other cases, NTP is the kick-off point for construction debt.
• “Commercial Operation Date” or “COD” is the term generally used by a project’s PPA or other offtake arrangement to signify that Substantial Completion (discussed below), facility operation, and interconnection to the grid have occurred. An offtaker’s obligation to purchase power generally begins no later than COD, and in many cases, tax equity investors will not fund their committed investment until COD has been achieved, a sign that the project has been fundamentally de-risked from a construction standpoint.
• “Begun Construction” is the concept used by the Internal Revenue Service (“IRS”) to determine a wind project’s eligibility for the PTC, as well as the value of the PTC for which it qualifies. Currently the PTC is subject to a phase down ending in 2021. The step-down in value of the PTC on a per-kWh basis began in 2017, and will be reduced to zero for wind projects that begin construction after December 31, 2020.
• “Mechanical Completion,” “Substantial Completion,” and “Final Completion” are terms most frequently used to describe the key completion milestones under an EPC contract. Mechanical Completion means completion of construction of the physical assets comprising the project but short of making the project operational and able to deliver energy to the grid (often accomplished by completing the construction of the project but not physically interconnecting it to the grid). Substantial Completion means completion of the project to the point where it is has achieved COD and has been interconnected to the grid, but with “punch list” items (i.e., items that are not essential to the achievement of COD) not yet completed. Final Completion means completion of all “punch list” items post-COD. Mechanical Completion and Substantial Completion are typically associated with solar project financing, and for good reason. Generally speaking, solar projects are financed (at least in part) by monetizing the U.S. federal investment tax credit (“ITC”), and those terms are critical to determining when the tax equity investor becomes an “owner” of the project³. Wind projects, on the other hand, predominantly utilize the PTC, which does not hinge on funding by tax equity investors at any particular time⁴. Final Completion, regardless of whether the project utilizes solar or wind power, signifies completion of the punch list and the end of the EPC scope. These three terms are not universal, and some EPC contracts use other nomenclature or have fewer or more milestones.

III. Tax Equity Financing. Tax equity financing is a creature owing its existence to the U.S. tax code, and is subject to the whim of federal politics and tax policy. As discussed more thoroughly in Chapter 10, the PTC permits an equity owner of a qualifying generation facility⁵ located in the United States to claim a tax credit based on an inflation-adjusted per-kWh hour price for electricity produced by that facility. The taxpayer need not own the facility on the date that it was placed in service to take advantage of the PTC; so unlike tax equity investors in solar projects that use the ITC, tax equity investors in wind projects can become owners at any time in the life of the wind project and still monetize the PTCs that arise from becoming and after the time they become an equity owner (but they cannot claim any PTCs generated prior to becoming an equity owner).

An owner may also be able to claim accelerated or bonus depreciation with respect to the cost of an asset. In combination, these benefits can offer a sizeable reduction to the federal tax liability of a wind project owner, allowing the owner to offset its taxable income based on the output of the wind project.

Most wind project developers do not have taxable income sufficient to take advantage of the PTC or the large tax losses created through the depreciation of project assets.⁶ As a result, a relatively small group of financial institutions and corporations with significant federal tax burdens have emerged to invest in projects as tax equity owners. The work of structuring transactions to permit these tax liability-laden investors to match up with qualifying wind projects and claim the benefit of the PTCs and depreciation is the central function and challenge of wind tax equity financing.

To maximize the PTC tax benefits, tax equity investors seek to accomplish several competing and sometimes conflicting goals. Federal tax law requires that investors put their dollars at risk in the project and share the benefits and burdens of ownership as an equity owner in order to claim the PTC.⁷ However, tax equity investors view themselves as purely financing providers, enticed to invest in the project only when offered a comparatively secure position resembling that of a lender. Tax equity investors are loathe to take on risks alongside the sponsor. Instead, they require certainty as to a project’s viability and construction completion before investing and demand that the transaction be structured to give them priority repayment and other fallback protections uncharacteristic of normal equity positions. Tax equity investors initially leave management of the project squarely in the hands of the sponsor, policing the management through covenants and representations and warranties in an operating agreement for the project company between the sponsor and the tax equity investors. On the spectrum of equity to debt, tax equity must sit squarely on the equity side of the line, but it wants to sit only barely over it.

One key way in which tax equity structures achieve this balancing act is through sponsor guaranties. The tax equity investor looks first to the project itself and the cash flow stream coming from the project to provide the required economic return. But management of the project is left to the sponsor, and, having no ability to rely on a collateral security position in any project assets, the tax equity investor is exposed to potential risks of the sponsor’s mismanagement of the project (e.g., breach of a project contract or other event leading to diminution in a project’s value). To counterbalance this risk, tax equity investors generally require that a creditworthy parent of the sponsor guarantee the project management obligations owed to the tax equity investors, protecting the tax equity investors from damages resulting from sponsor-side breach of covenant, misrepresentation, environmental liability, and, depending on the transaction, post-funding change in tax law.

Tax equity structures rely largely on the principle of bifurcation. In the partnership flip structure, the tax items of a partnership are allocated separately from the partner’s respective cash flows and management rights.

A. Partnership Flip. Over the years, the partnership flip structure has become the standard vehicle for PTC-driven tax equity investments. The core of the structure is the operating agreement for the LLC that directly owns the wind project. When tax equity makes its investment (assuming the sponsor has not already brought in a cash equity investor at the project company level) the project company becomes a partnership, and the operating agreement sets forth the allocation of cash and tax benefits between the partners. As an LLC, the project company is a “pass through” entity for tax purposes, meaning that there are no income taxes due at the partnership level. Rather, taxes are paid on the partners’ (or their upstream owners’) corporate tax returns. Likewise, any tax benefits realized by the project company are allocated to the partners under the operating agreement and passed through to the taxpayer.

In a partnership flip transaction, the allocation of cash and tax benefits under the operating agreement will “flip” between the partners one or more times during the life of the partnership. In a typical scenario the tax equity investor will realize the vast majority (often 99 percent) of the tax benefits either until the end of the 10-year PTC period or an earlier stated date (a time-based flip) or until it reaches its target return (a return-based flip), after which the allocation “flips” and the sponsor receives the majority (usually, but not always, 95 percent) of the remaining tax benefits. Under the safe-harbor rules promulgated by the IRS that govern these transactions from a tax standpoint, the tax equity investor must retain at least a 5 percent residual interest in the project company.⁸ From the sponsor’s point of view, the tax equity investment⁹ allows the sponsor to maximize the value of tax credits that it could not otherwise use while retaining management control of the project and receiving a separately allocated portion of project cash.

While the sponsor is receiving only 1 percent of the tax benefits during the early years of project operations, cash generated by the project (e.g., through the sale of electricity and renewable energy credits) can be, and most often is, distributed to the partners in completely different percentages than the tax profits and losses.¹⁰ The allocation of tax benefits and project cash, taken together, is negotiated between the parties up front to balance (1) tax equity achieving its target return within a defined period of time (generally between nine and 10 years) and (2) the sponsor receiving as much cash as possible during operations.

By utilizing this structure (often called a “disproportionate allocation partnership”), the sponsor minimizes the tax credits and deductions it receives, having effectively monetized the lion’s share of such tax credits and deductions by allocating them to the tax equity investors in exchange for the tax equity investors’ investment, while at the same time receiving what can be very substantial cash flow from the project in the form of its share of the distributable cash.

B. PAYGO. What happens in a time-based flip where the tax equity investors receive their target return before the end of the PTC period (i.e., before the end of the 10th year after the last wind turbine at the project is placed in service)? After all, the project will not stop generating PTCs until the end of the PTC period. Sometimes, the tax equity investors will opt to stay in the deal during that period and agree to make capital contributions to the project company post-flip in exchange for the PTCs that the sponsor does not want or cannot use—referred to as a “PAYGO” (abbreviation for “pay-as-you-go”). The amount of the tax equity investors’ additional capital contributions is often capped, and the price paid for the PTCs may be less than the $/MWh value of the PTC applicable to the project.

IV. Project-Level Debt.

A. Overview. Though debt financing has been overshadowed in the wind industry by the prevalence of tax equity, the progressive step-down of the PTC¹¹ portends that wind projects will increasingly be financed with some manner of debt. Debt is, at its core, a contractual obligation by a borrower to repay a sum of borrowed money that will, if secured by a perfected first lien on the project assets, have a claim for the amounts owed that is senior to the borrower’s other creditors. In comparing the spectrum of financing options, debt tends to be a “safer bet” than any sort of equity financing, representing the prospect of limited risk (payment priority and, often, assets pledged as collateral securing repayment) for limited rewards (an interest rate and possibly other lender fees, but no further upside).

For wind projects, it is useful to classify debt primarily in relation to a project’s lifecycle. Roughly speaking, there are three categories of debt for wind projects, each discussed in more detail immediately below: (1) development-stage debt for the pre-construction period, (2) construction debt to finance the period of active EPC work, and (3) permanent debt for the post-construction period when a project is operational and development work is complete.

B. Development Loans. Development loans can involve a variety of structures to finance early-stage project development work, including upfront interconnection deposits, PPA deposits, wind resource assessments, permitting, and site control costs. As the value of the project assets remains somewhat prospective at this early stage, development lenders may forgo a full collateral pledge of project assets, opting to rely solely on a pledge of project company membership interests, or may require security interests in deposits and material assets. There is no established market for a typical development-stage loan, and terms vary widely among what are fundamentally bespoke deals. Many entities act as development financiers in order to claim a seat at the project table, for instance, entities interested in buying or funding the project if early-stage development proceeds to full construction, contractors looking to secure the project’s EPC work, or turbine manufacturers looking to ensure their product is used in the project. In certain instances, development loans can also be a bridge to future funding, providing a quick, relatively low-cost transaction with minimal documentation; a very short tenor; little borrower flexibility without lender consent; a high interest rate; and a promise to grant the lender a right of first refusal to the next round of larger financing or, in the case of a strategic investor, the option to buy the project.

Though we speak here of development loans as debt instruments, many early-stage investments involve collateral security and operational covenants securing a future payment (and are thus debt-like in their protections) without the payment obligation actually constituting indebtedness on the obligor’s balance sheet. One such variant appears commonly in early-stage membership interest purchase agreements (“MIPAs”), where project sellers may retain a lien on the equity interests or assets of a project sold to secure full payment of the MIPA purchase price, which may provide for staggered payments to the seller upon NTP or other development milestones. Though the payment obligation secured (the purchase price) may not technically be indebtedness, the creation of the lien on the SPV equity interests or project assets makes this structure function similarly to secured indebtedness.

C. Construction Loans. A project’s capital needs are highest during construction, when all equipment and component parts must be purchased and contractors and subcontractors are engaged in on-site physical work and must be paid on schedule. There are long-term implications of a construction process running over budget or behind schedule. Payment streams must be managed, aligning invoices for required uses of cash with sources of cash from equity or debt funding or liquidated damages claims from tardy counterparties. As such, construction loans tend to be the most procedurally complex loan transactions, involving the most detailed covenants outlining what a project may or may not do and imposing the highest hurdles to accessing funds.

Tax equity investors will generally not take construction risk with their funds. Thus, the task of financing construction falls to lenders and sponsors together. In order to ensure proper alignment of the sponsor’s incentives, and to avoid extending loans beyond the project’s expected collateral value, construction lenders generally require a certain minimum sponsor equity contribution as a condition to any construction loans being funded, often expressed as a percentage of expected project costs. Further, construction debt commitments will be sized to avoid a project exceeding a certain debt-to-equity ratio. If construction costs exceed budgeted contingency amounts, projects will fall back on any cost overrun guaranties or available contractual liquidated damages, but ultimately if no other sources of cash are available, it will be up to the sponsor to provide financing or risk losing the project to the secured lender.

Hallmarks of construction loans include the following:

• Very tight and detailed covenants, restricting all project activities other than development in accordance with the permitted construction contracts, prohibiting amendments to project contracts or project design plans without lender consent, restricting transactions between the project company and its affiliates, and requiring detailed progress reporting to the lenders and an independent engineer.
• A construction cash flow waterfall governing all project cash, which requires all available cash flows to be applied to pay budgeted project costs and lender fees and expenses, with any excess required to be applied to debt service as mandatory prepayments. Since wind projects do not generate revenue during construction (other than payments for test power or merchant sales late in the construction process), available cash flows generally include only construction loan proceeds, any equity contributions or proceeds from equity issuances, any liquidated damages payments from counterparties, and any insurance proceeds received. Construction debt documents typically prohibit any cash distributions to equity holders during the construction period.
• Construction loan collateral packages are generally straightforward: all project assets. This entails a pledge of equity interests in the applicable borrower-side entity or entities, as well as the project company granting a security interest in all its real property interests (whether a leasehold interest, fee ownership, or other access or easement rights), all project contracts (including construction and development contracts, PPA/offtake arrangements, and asset management and operations and maintenance contracts), all permits, all cash, and all equipment and materials.

In addition to taking collateral assignments of the contracts from the project owner, the lender will also require that each counterparty to a material contract consent in writing to the collateral assignment of such material contract to the lender, which consent will include, among other things, an acknowledgment of the lender’s rights, an agreement to give the lender notice of any default by the project owner, and a grant to the lender of certain rights to cure defaults by the project owner. Consents may also include a so-called bankruptcy replacement clause whereby the counterparty agrees to enter into a replacement agreement with the lender in the event the project owner is the subject of a bankruptcy proceeding. Finally, when payments are or may be owing by the counterparty to the project owner under the contract (for example, the PPA or other offtake arrangement), the consent also will include a provision directing those payments into an account controlled by the lender.

To ensure the project will benefit from a tax equity commitment, including after a foreclosure by the lender, construction loan collateral packages may also include pledges of upstream equity interests or interests in the tax equity transaction documents containing the tax equity commitment.

• Staggered construction loan fundings. Rather than extend the full amount of the construction loan commitment upfront, lenders generally disburse loans for budgeted project costs as such costs become due, and the loan proceeds are immediately applied to invoiced project costs then due. As standard contract payment terms require payment within 30 days of invoicing, projects typically borrow construction loans once or twice a month during construction. Lenders typically also require lien waivers from contractors, subcontractors, and major equipment suppliers as a condition to each construction loan used to pay such counterparties, and the title company will require such lien waivers in order to issue a customary date-down endorsement to the title policy insuring the lender’s security interest in the project.¹²
• A breach or default under any tax equity transaction document (in addition to a breach or default under any loan document or material project document, or any other event reasonably likely to have a material adverse effect on the project) will typically prevent the borrower from accessing any further construction loans. As the tax equity investment often serves as a source of repayment for a portion of the construction debt, lenders are wary of any event that could jeopardize the tax equity investment.

If a project financing involves both debt and tax or cash equity, the construction loan will be sized to be repaid from some combination of the permanent term loan and the tax or cash equity investment. Thus, construction loans are often earmarked by tranches to refer to the expected source of repayment (for instance tax equity bridge loans as the bridge to a tax equity commitment). These tranches may have different features, including different interest rates or disbursement requirements.

D. Permanent Loans. Following achievement of COD and completion of construction of a wind project, a sponsor will typically trade its restrictive and expensive construction debt for (or convert it into) permanent financing, allowing recoupment of invested capital. It is often the case that the construction loan will be converted to permanent financing when certain conditions are met (the conditions generally being that the project has achieved commercial operation and the tax equity investment is funded). The permanent financing often has a comparatively gentler set of loan terms than during construction, since the tighter restrictions used to protect the lender against construction risks are no longer needed. Though covenants, collateral security, and defaults remain tight to ensure that project ownership and operation protects the facility and maximizes the revenue stream, the lender takes a somewhat more passive role in supervising operations than during construction.

It should be noted that the financing is “permanent” only in the sense that it is put in place post-construction (even permanent debt becomes due on a maturity date). The permanence aspect of long-term project financing is that project revenues will cover debt service to significantly (or fully) pay down the loan before the maturity date, thus slotting permanent debt in the category of permanent financing solutions that operating companies typically rely on. The term of the permanent financing may be as short as five years (with a balloon payment at the end of the term that will require another financing) and is not necessarily in place for the useful life of the project. Terms of 12 to 15 years are not unusual, although most permanent lenders will require that the term be somewhat less than the term of the related PPA, to allow a buffer in the event the project encounters performance problems. Thus, “long-term” debt or “take-out” financing (i.e., that takes out the construction debt) is a more descriptive name than “permanent” debt.

Permanent loans are generally single-draw term debt, with one funding on the date when the construction loan “term converts” or “terms out.” When coupled with tax equity or cash equity, the term conversion will occur simultaneously with investor funding, and the closings will be cross-conditioned.

1. Cash Flow Waterfall and Distributions. A key aspect of permanent project debt is the cash flow waterfall, through which project revenues are used to pay project expenses, lender expenses and debt service, and investor returns in a pre-determined priority. Many variations exist, but in general lenders permit cash flow to be applied as follows, on monthly or quarterly dates: first, to pay project operating expenses; second, to pay lender expenses not constituting debt service; third, to pay debt service (interest and scheduled principal payments); fourth, to fund any required cash reserves for the project, including reserves for debt service, maintenance expenses, and capital expenses; and fifth, to make distributions to the equity owners (subject to satisfaction of negotiated distribution tests as described below). To the extent the sponsor performs asset management or similar services through a contractual arrangement with the project, these costs will generally be paid at the priority first as operating expenses. Any other equity return comes solely from the last priority.

   Permanent project loan agreements typically only permit distributions to the equity owners if the project can demonstrate compliance with a specified financial covenant, any required cash reserves for the project are fully funded, and no default or event of default exists. The financial covenant usually is a Debt Service Coverage Ratio (“DSCR”) test, which requires that net revenues (i.e., those remaining after payment of operating expenses) over a certain period (typically a one-year period) exceed required debt service during that period by a certain ratio, e.g., at least 1.25:1.00. If the distribution requirements are not met at the time the waterfall is run, available cash will be trapped in a secured account and the borrower will not be able to distribute the cash to the equity owners until such requirements have been met. Funds that remain in the secured account for a specified period of time as a result of a failure to meet the distribution requirements on successive testing dates often will be required to be used to prepay the loan.

2. Back-Leverage Debt. Because of the need to monetize the PTCs and depreciation through a tax equity financing, most wind projects do not utilize debt financing at the project company level. Under applicable federal income tax rules, the existence of debt at the project company level can result in large deficit reduction obligations on the part of the tax equity investors—something that tax equity investors seek to avoid or limit. Furthermore, at current PTC levels, the tax equity financing itself generally provides funding for about 40 to 50 percent of the project costs, and thus effectively replaces a large portion of the debt that might otherwise be incurred to finance the project. However, that still leaves a large percentage of the project costs to be funded by an equity contribution from the project sponsor—requiring an amount of available capital that wind developers without access to a substantial corporate balance sheet cannot readily provide. Hence the use of so-called “back-leverage debt.”

Back-leverage debt involves a loan at a level above the project company where the project sponsor (or more likely a holding company formed by the sponsor for such purpose) is the borrower. By moving the debt financing up the chain, (1) the sole collateral securing the debt is the sponsor-side equity interests and the associated cash held by the holding company borrower, (2) tax equity avoids the consequences of unacceptable large deficit restoration obligations, and (3) the sponsor leverages its investment by using the debt to replace a portion of its equity contribution, enabling it to recycle that equity in to other projects.

But why is the sole collateral securing the debt the sponsor-side equity? Why would the back-leverage lender not take a security interest in any of the wind project assets? The answer is simple: tax equity will not allow its investment in the project to be put at risk for a borrowing that only benefits the sponsor, which is what would happen if the project assets were subject to a lien securing the sponsor debt. In short, tax equity investors do not like to take this sponsor risk.¹³ When placed in an upper tier of the capital structure above project-level secured debt financing, tax equity investors and sponsors share much of the same perspective on two key risks: (a) upon an event of default under the loan agreements, a secured lender could foreclose on the project assets or an equity pledge and sever the ownership chain between the upstairs owners and the project and (b) loan agreements impose distribution restrictions that can cut off cash flow streams. While tax equity investors can bear these risks during a brief overlap period in respect of construction loans (subject to extracting certain terms from lenders via interparty agreements, as more fully described below), tax equity often views these two risks as non-starters in permanent loans and will not allow any liens on the wind project assets. Instead, the lender is secured by a collateral assignment of the holding company’s membership interest in the project company, often supported by a guarantee from the sponsor’s parent.

Given that the back-leverage lender is not secured by the project assets, the lender pays particular attention to the holding company’s right to receive project company cash flows sufficient to service the debt. The details of project company cash flow distributions vary depending on the particulars of the project, the perceived risks, the nature of any parent guarantee backstopping repayment of the debt, and the structure of the tax equity financing. But the ultimate goal is to structure an arrangement that, under various downside scenarios, is calculated to provide the sponsor with sufficient cash flow to service the debt and keep it out of the “nonperforming loan” category while not diverting funds from tax equity that would unduly delay the tax equity flip date.

V. Cash Equity Financing. As an alternative to back-leverage debt, some project sponsors seek to bring additional capital to the project by bringing in a “cash equity” investor in addition to the tax equity investors. Like back-levered debt, this cash equity financing effectively takes place at the sponsor level, although it can involve either a direct equity investment in the project company or investments by both the sponsor and the cash equity investor in a holding company that owns the sponsor equity in the project company.

Under a tax equity financing structure, the sponsor and tax equity investor own separate classes of membership interests in the project company. If the sponsor brings in a cash equity investor, it has two options: (1) the sponsor can sell the cash equity investor a portion of the sponsor membership interests in the project company or (2) the sponsor can sell the cash equity investor a portion of the membership interests in the holding company that owns the sponsor equity in the project company. Whether one structure is selected over another depends upon the terms of the deal between the sponsor and the cash equity investor. From tax equity’s perspective, all sponsor-side equity should be treated the same (or, said differently, tax equity expects the same treatment from each other equity investor in the project company). It can therefore simplify negotiations somewhat by having the sponsor take the lead on negotiations with tax equity on behalf of the holding company. In that scenario, any special arrangements between the sponsor and the cash equity investor (e.g., preferred returns) would be addressed solely between them in the “upstairs” holding company LLC agreement. Tax equity would have no insight into that arrangement, nor should it, since the sponsor and the cash equity investor would be sharing the holding company’s portion of project company returns. And if the cash equity investor is coming in during negotiation of the tax equity deal, then regardless of which structure is selected, the sponsor should expect that the cash equity investor will be involved behind the scenes in determining the holding company’s position on issues like allocations, distributions, cash traps, and indemnification obligations at the project company level.

The cash equity investor thus becomes an owner of the project company and shares in the return that would otherwise go to the sponsor. The sponsor generally provides the cash equity investor with indemnities and guaranties on various project stress points similar to those provided to the tax equity investor. In some cases, the cash equity investor may get exactly the same indemnities and guaranties, effectively de-risking cash equity’s portion of the holding company cash flows in exactly the same manner that tax equity protected its cash flows. That said, both the tax equity investor and the cash equity investor take on real project risk—if the project fails to perform, neither may realize the return it seeks.

Cash equity investments can be structured in a manner that makes them function like back-levered debt. Under such an approach, the cash equity investor gets a preferred return designed to amortize its investment over a target term and provide an agreed upon return. A preferred return interest is usually structured so that it constitutes “debt” for tax purposes, thus allowing the sponsor to deduct the “interest” (or return) portion of the preferred return.

But even if the preferred return functions like debt, the cash equity investor’s right to repayment is not the same as the right of a lender to repayment of its back-leverage loan. If the project performs well, the preferred return payment schedule will be met in a timely manner and upon payment of the preferred return, the cash equity investor will cease to have any rights to the project company (or holding company) cash flows (and typically has no further voting rights on project company matters). But since this is a true equity investment, the cash equity investor takes the risk that if the project does not perform properly, it may never realize its desired return. Unlike true debt, payment of the preferred return is not an absolute obligation, but rather one that is only paid to the extent the project generates sufficient cash flow.

Cash equity investors also have greater rights with respect to the management of the project company than the typical back-leverage lender. Whether as members of the project company or as members of the holding company that owns the sponsor equity interest in the project company, the cash equity investor typically has various rights and controls, including approval rights with respect to the project company budget and a long list of potential actions usually defined as “major decisions” or “fundamental decisions.” While lenders, through affirmative and negative covenants, can secure comparable rights, since they are not direct or indirect members of the project company, those rights are one step removed from the action and far less “hands on” than the rights afforded cash equity investors.

With the scheduled demise of the PTC, there is likely to be a rise in both traditional project level debt financing and cash equity financing of wind projects. As long as wind resources remain attractive to load-serving entities and commercial and industrial offtakers, history indicates that there will be ways of financing them.

VI. Conclusion. Many more topics could be covered under the heading of wind project finance: insurance requirements, interparty issues between tax equity investors and lenders, monetization of tax credits and other tax benefits, issues relating to transmission and imbalance charges, the fine details of the evolving offtaker market, and other major project agreements. While the foregoing treatment is not exhaustive, it nevertheless provides a framework for approaching these and other topics. No matter what aspect of wind project financing one examines, the essential dynamic at play will be the search for credit and the corresponding effort to reduce or eliminate risk.

¹ The minimum investment grade ratings from Moody’s Investors Service and Standard & Poor’s Corporation are “Baa3” and “BBB ,” respectively.
²It should be noted that loans made directly to the project company SPV are rare for wind projects as they have adverse impacts on the tax equity investors, and hence most debt financing for wind projects is back leverage debt incurred above the project company SPV. Because tax equity investors are true equity owners, they are not secured by interests in the project assets. Instead, they typically have full recourse to the sponsor for various indemnification obligations.
³For a more comprehensive discussion of the ITC, see Chapter 10.
⁴Fundamentally, the ITC would only be more valuable (relative to the PTC) for expensive, lower producing facilities.
⁵Importantly for wind projects, each individual wind turbine is a separate “facility” for PTC purposes.
⁶Over time, we have seen more and more strategic investors enter the industry as owners/operators. As the operations of those investors in the United States has grown, their appetite to use the tax benefits themselves has also grown. Nevertheless, both traditional project developers and such strategic investors most often seek to leverage their position by bringing in third-party tax equity investors. Tax equity investments allow owners of all stripes to bring forward a portion of their profit in the form of the premium paid by the investors for an interest in a project that has been virtually (if not entirely) de risked from a construction standpoint, thereby replenishing capital that can be deployed elsewhere.
⁷An investor cannot claim any PTCs to offset taxable income if the PTCs in question were generated prior to the investor being an equity owner of the project. Such pre investment PTCs are thus “lost” in the sense that they have no value to the tax equity investors and hence are not part of the tax benefits monetized through the tax equity financing. To minimize any such loss of PTCs, tax equity financings are most often designed to have the tax equity investors become equity owners as close as possible to the date the first turbine is placed in service for PTC purposes.
⁸As noted above, the 5 percent residual interest is required for PTC qualification to ensure that the tax equity investor is truly an equity investor, and its investment is not treated as debt despite the various lender like protections built into the operating agreement (e.g., cash sweeps). Typically, the sponsor will have a buyout right with respect to the tax equity investor’s interest in the project company after the flip. But if the buyout option is not exercised, the tax equity investor would be a long term minority interest holder in the project company.
⁹The tax equity investment typically amounts to approximately 40 percent of the total project cost, though depending on the particular tax equity financing structure employed and the nature of the project, tax equity may fund 50 percent or more of the total project costs.
¹⁰Note that cash generated by a project does not always give rise to taxable income. Owing to depreciation and operating expense deductions, it is typically the case that in the early years of operation, a project generates significant cash flow but little, if any, taxable income.
¹¹The PTC for projects that began construction in 2017 is 80 percent of its nominal value. The PTC for projects that began construction in 2018 is 60 percent of its nominal value. The PTC for projects that began construction in 2019 is 40 percent of its nominal value. The PTC for projects that began construction in 2020 or 2021 is 60 percent of its nominal value. For projects that began construction after December 31, 2021, the value of the PTC is zero.
¹²For a more comprehensive discussion of title issues, see Chapter 2.
¹³As noted above, tax equity will seek to avoid taking any sponsor risk to the extent it can be avoided. A key means of protecting themselves against identified risks is through sponsor indemnification obligations supported by a guarantee from a creditworthy parent.