FIT 2.0 for lenders

April 12, 2012

The Ontario Power Authority issued draft FIT program rules, draft definitions and a draft FIT contract for stakeholder comment on April 5, 2012. Information on submitting comments on these "FIT 2.0" documents is available on the OPA's website. Comments are due by April 27, 2012. A ministerial directive to the OPA concerning the FIT program was issued the same day.

Lenders should be aware of some important differences in the terms of the current FIT program and the proposed FIT 2.0. As well, the changes to the program will affect the types of projects that are most likely to move forward and therefore the types of projects lenders will be asked to finance.

Projects with aboriginal or municipal council support will be prioritized, as will those with equity participation from aboriginals, local community members, public schools, colleges, universities, hospitals and long term care facilities. Contracts will be awarded in batches, with the first batches to be for microFIT and small FIT projects. It is unclear when the next round of large FIT contracts will be offered. In addition, opportunities for ground-mount solar projects are limited, due to additional restrictions on siting these types of projects. Taken as a whole, the effect will be that projects receiving FIT 2.0 contracts will by their nature tend to present additional challenges for lenders.

Specific issues for lenders to consider under the draft FIT documents are discussed below.

It is important to note that one significant issue for lenders is not addressed in the draft FIT contract. The draft contains a note to the effect that the protective provisions in the current FIT contract dealing with changes to electricity market rules by the Independent Electricity System Operator will be amended in conjunction with the IESO's current renewable integration initiative (SE-91). Lenders will need to wait for further progress on the IESO front before they will be able to understand the potential economic risks to a FIT 2.0 project resulting from curtailment

Changes to Facility
Under the existing FIT contract, the OPA was not permitted to unreasonably withhold consent to material changes to a facility. The new FIT contract allows the OPA to withhold consent for material changes to a facility in its sole and absolute discretion. This may limit an electricity supplier's ability to change the connection point, feeder, transformer, site location, design or layout of the project after the application is made. Lenders will need to pay even greater attention to their technical diligence to ensure there is unlikely to be any need for changes to the facility after financial close.

Liquidated Damages for late COD
The new FIT contract requires all electricity suppliers to pay liquidated damages of $0.25/kW multiplied by the contract capacity of the facility for each day of delay in achieving commercial operation beyond the Milestone Date for Commercial Operation specified in the contract. (This only applies to a limited subset of projects under the existing FIT contract.)

Like the existing FIT contract, the twenty year term (forty years for hydro) of the new FIT contract commences on the Milestone Date for Commercial Operation even if commercial operation has not been achieved by that date. However, under the new contract the right of the supplier to "buy back" the truncated portion of the term has been eliminated. The term may now only be extended at the option of the OPA. Lenders will want to give careful consideration to the possible impact of these new provisions on project economics in the case of delays to commercial operation, and consider whether risk mitigants such as additional reserves are required as a result. This issue is likely to be of particular concern for lenders to rooftop solar projects, which will have eighteen months to reach commercial operation under the new FIT contract (in contrast to three years under the existing contract).

Domestic Content
The current FIT contract requires the OPA to respond within 60 days of its receipt of a domestic content report; however, the new draft proposes only a "reasonable" time period. The draft provides that the electricity supplier and the OPA will cooperate to finalize the domestic content report "within a reasonable time period" if the OPA finds the domestic content report deficient following its initial submission while the existing FIT contract provides the supplier with 30 days to respond to deficiencies and gives the OPA an additional 30 days to review those responses. Lenders were already uncomfortable with the post-COD nature of the domestic content report, so the lack of firm time lines is likely to add to this discomfort.

Termination for Convenience/Stop Work Direction
The existing FIT contract permits the OPA to terminate the contract prior to obtaining Notice to Proceed (though this right was waived by the OPA in many cases). Since receipt of Notice to Proceed is typically a condition precedent to financial close, this is not an issue of concern on a typical project loan transaction (although it may of relevance on portfolio level financings, depending on the conditions precedent for each draw).

The new FIT contract introduces a right for the OPA to terminate the FIT contract for convenience on 20 days' notice even after the issuance of Notice to Proceed. If the OPA exercises this termination right, the supplier is entitled to return of its completion and performance security, and payment of accrued amounts owing to it under the contract, plus its "Sunk Costs" (defined as the reasonably incurred costs to develop, construct and commission the facility) and the net present value of the supplier's anticipated profits during the term.

Of even greater concern, the new FIT contract introduces a right for the OPA to issue a "Stop Work Direction". This direction requires the supplier to permanently cease development and construction of the facility. Although one section of the new draft expressly entitles the OPA to issue this direction prior to issuing Notice to Proceed, in another section there is no time limitation. As such, it appears the OPA would also have the right to issue a Stop Work Direction after Notice to Proceed (or possibly even after COD, since it is unclear when "development and construction" is complete). Under the current drafting, it is also unclear whether the supplier is entitled to any compensation if it receives a Stop Work Direction.

In addition to the risk of not receiving compensation sufficient to pay out their loans, lenders will also want to consider what rights they will require vis-à-vis the supplier if a termination notice or Stop Work Direction is issued. For example, the FIT contract specifies a process to determine the amount of compensation payable to the supplier for termination for convenience by the OPA. Lenders are unlikely to want to sit on the sidelines and leave such an important issue to be determined without their input and involvement.

Force Majeure
The force majeure provisions in the new FIT contract are less supplier-friendly than those in the current contract. Specifically, a supplier will not be able to invoke force majeure to the extent that the event was within the reasonable control of the supplier or resulted from a failure of performance of a third party (unless the failure of performance of the third party was itself caused by a force majeure event as defined in the new contract). As well, if requested by the OPA, the supplier must provide evidence to demonstrate that it has made commercially reasonable efforts to remedy the force majeure situation and must represent and warrant that such evidence is complete and not misleading. Lenders are likely to focus on this issue most closely during the pre-COD period, particularly given the shorter milestone dates for rooftop solar discussed above.

Lender's Rights
A few changes have been made to the "Lender's Rights" section of the contract.

First, the draft FIT contract now permits lender's security agreements to cover assets and to secure debt relating not just to renewable generating facilities owned by the supplier, but also to those owned by affiliates of the supplier. This should generally facilitate cross-collateralization and portfolio-wide financings. However, microFIT facilities are not permitted to be included in multi-facility security agreements (although it is rare that a microFIT facility would be included in a portfolio given the restrictions imposed in that program). Also, a requirement has been added that the other renewable energy facilities included in the security agreements must be the subject of a contract with the OPA. This will make it more difficult to use projects in earlier stages of development as collateral for the financing of contracted facilities, and vice versa.

Second, while the current FIT contract includes the form of consent and acknowledgement agreement that the OPA will enter into with the lender, the draft contract refers only to an agreement "in the Prescribed Form". We believe the likely explanation for this change is that in some cases suppliers and lenders have entered into an out-of-date version of the agreement based on the form attached to the FIT contract, rather than using the version available on the OPA website, which has undergone some changes. Detaching the form of agreement from the FIT contract will eliminate this problem. However, given the crucial nature of the consent and acknowledgement from a lender perspective, it would have been helpful either to see the proposed new form or to get confirmation that the current form will continue to be used under the new FIT contract.

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