Every energy equipment supplier contract brings risk

By Peter V.K. Funk, Jr.
Mission Critical magazine
October 1, 2011

In my most recent column, I noted that Solyndra made a solar product that could find application in the data center industry. To my surprise, Solyndra recently put itself into a Chapter 11 bankruptcy, citing Chinese competition as a significant factor. Worse, the company has become part of a political controversy since it was the subject of a photo op with President Obama and received Department of Energy (DOE) loan guarantees. Even worse, recent front-page pictures show investigating FBI agents standing by the Solyndra headquarters building (a sight that should give pause to other DOE loan guarantee recipients).

While counter-party risks do not typically rise to such a dramatic level, this situation points up the need for careful assessment of risk factors associated with suppliers of on-site generation equipment. Failure of a supplier can put both long-term reliability and short-term mission critical performance at risk.

Long-term Reliability

Solar products are a good example of the importance of long-term performance warranties. A photovoltaic installation has an anticipated service life of 15 to 20 years, and manufacturers' warranties typically provide that the performance of the solar modules will not diminish below 80 percent during that time.

Let’s say that you purchased Solyndra PV equipment prior to its bankruptcy filing. The warranties, particularly the long-term performance warranties, provided by Solyndra were essential to your purchase. What happens now? Will Solyndra, in bankruptcy, be willing and able to honor its warranties? A partial answer to that question is its motion to the Delaware Bankruptcy Court in which Solyndra sought authority to "Maintain and Administer Warranties" on pre-petition equipment sales. Solyndra's motion as granted by the court, however, contains a “barn-door” exception: Solyndra may elect, but is not required, to honor its warranties. Covered parties would include distributors so if your panels are sitting in a warehouse or on your roof, you may have warranty coverage in the event that Solyndra: (i) elects to cover its warranty, (ii) continues in business, and (iii) is able to service its warranty or, alternatively, a solvent company that acquires Solyndra assumes the warranty risks.

Such long-term warranty risks extend beyond bankruptcy situations. Since any performance warranty is only as durable as the company giving the warranty, it is important to conduct a risk analysis of that company's future ability to service its warranties. Such an analysis might also be part of a credit review that a lender performs in connection with a loan to a developer or facility owner installing on-site generation since the lender is concerned not only with the credit of the borrower, but also with the viability of the project to the extent that its viability affects the borrower's ability to pay make loan payments. In addition to reviewing financial information, due diligence of a supplier might include: What is the viability of the company in the marketplace? How is the manufacturer faring relative to its competitors? What are its long-term prospects? How well does it handle servicing warranties? Though providing warranty insurance would appear to be an area ripe for offering coverage, insurance companies generally avoid providing warranty insurance out of concern with controversies that can occur over warranty coverage.

A purchaser's exposure to risk can be compounded when it buys on-site generation equipment from a vertically structured company that manufactures, distributes, installs, and maintains the equipment. Contracting with a vertically structured company providing such a range of services can confer undeniable benefits such as: (1) an avoidance of "finger-pointing" when problems occur (a typical problem when dealing with several companies); (2) an avoidance of dealing with manufacturers on a "second-hand" basis when construction contractors procure the generation systems and pass along, but do not assume, warranties; and (3) "one-stop shopping." The inescapable reality, however, is that you, the purchaser, also, in effect, have one-stop shopping when it comes to remedies against vertical companies since you are relying upon a single company to provide comprehensive services and warranties over a long time period.

Short-term Performance

The capabilities of providers (including manufacturers, contractors, and service companies) become even more critical when the services provided include emergency repairs and/or remote monitoring of on-site generation. A provider in financial difficulty may desire to remain in contract with the purchaser and be unwilling to throw in the towel such that a purchaser would then be contractually free to correct the failure by making other arrangements.

Unless there is a "self-help" provision in the services or supply agreement (or in a Solyndra situation, a provision states that bankruptcy constitutes a default) or the agreement includes applicable contractual "off-ramps," a purchaser may be stuck for an undesirable period of time with an underperforming provider. This might happen, for example, when a purchaser is able to successfully claim a breach of the contract but the agreement includes a contractual right to cure "within a 30-day period or, if the default cannot be remedied within a 30-day period, for so long as the provider is making diligent efforts to remedy the default." Such a provision (reasonably common in service agreements) provides scant comfort to an owner, such as a data center operator, with an on-site cogeneration or emergency backup generation system who is seeking to get its system back in operation.

In short, uncertainty regarding the provider can become a serious issue even prior to a provider’s failure. My clients who have installed or received Solyndra products face uncertainty as to whether Solyndra will elect to service the warranties and, if so, whether it will continue to have the ability to service these warranties. Those clients who have contracted to purchase Solyndra products, but have not received them, face even greater uncertainty since the order of the Bankruptcy Court covered only purchased products and without a warranty it may not be possible to register to qualify to receive Solar Renewable Energy Credits or SRECs (for states that have such a requirement such as New Jersey).

Another financial problem that occurs is when the purchaser receives credible informal information that the provider (such as a supplier which is expanding more rapidly than its balance sheet and credit permits) is beginning to experience financial difficulties. A check of credit agencies shows that these have not yet reported any difficulties — and may even show a favorable situation. A purchaser is concerned about making payments for goods not yet delivered. How does a purchaser verify that the supplier is able to perform? One remedy exists in the Uniform Commercial Code (UCC) § 2-609. "Right to Adequate Assurance of Performance." When reasonable grounds for insecurity arise with respect to the performance of either party, the other may send it a written demand for adequate assurance of due performance and until such assurance is received, may, if commercially reasonable, suspend any performance for which the agreed return (such as a delivery of equipment or payment) has not been received.

Purchasers of on-site generation equipment can pay great attention to the characteristics of the equipment to be provided and scant attention to the characteristics of the company providing the equipment and the terms of the agreement under which the equipment is being provided. This lack of attention can come back to haunt the purchaser. As to contracts, in particular, be careful about the portion of the contract the sales personnel describe as "standard form boilerplate." I caution my clients to assume that there is no such thing as boilerplate and to further assume that the counterparty will fully enforce each and every provision of an agreement. Due diligence is also key, particularly when contracting for one-stop shopping with a vertical company, since, in that case, the procurement decision should be based as much upon a risk assessment of the providing company as upon the equipment and services to be provided by that company.