Everything You Need to Know About Solar Leases
Dating back thousands of years, humans have utilized various forms of solar powered energy. In older civilizations, humans used the sun to start fires with glass. In more recent history, the development of solar panels has enabled us to generate and store power from the sun as electricity. The use of solar panels to generate and store electricity in America has become increasingly popular over the last few decades as technology has improved efficiency and as the government has offered incentives and tax benefits to encourage renewable energy which has increased the volume of solar lease transactions in recent years.
This article will explore some of the more important issues to consider in larger scale solar leases, which are usually put in place on agricultural or vacant land. These leases are typically entered into between an owner of a large parcel of land and a company that is looking to generate and store solar power, either for its own personal use or for sale to third parties for a profit. The solar company locates suitable locations to develop a solar energy system, invests the capital to install the system, and then generates/stores the power.
There is often a due diligence period that takes place before a solar lease term commences. During the due diligence period, the solar company is given a period of time in which they have access to the property to evaluate its viability for energy production and to determine how much energy can be produced. The solar company should pursue any necessary governmental/municipal approvals for the proposed use during this period. If the property is deemed to be unfit for the solar company’s proposed scale and use, the lease can be terminated during the due diligence period and the landowner would generally be free to lease to another company (assuming there is no right of first refusal, option, or other exclusivity agreement granted by the landowner).
Landowners should be cautious about granting a long due diligence period or a long-term option period to a solar company, as this may limit the landowner’s options and permitted uses of the property for an extended period of time. For example, if an exclusive option is given to a solar company over a portion of the land for a period of years, the landowner will not be able to interfere with the option or exclusive rights given to the first solar company. Thus, a landowner may be precluded from putting the land to other use for that period of time (including turning down firm commitments to lease the land). If options or exclusives are being granted, the landowner should negotiate financial compensation commensurate with the time period for lost opportunity of use of the land. In addition, landowners should try to propose a right of first refusal as opposed to an outright exclusive provision to avoid having certain portions of the property left unused and without generating rental income.
Similar to any other lease, the parties also need to agree on the major terms, such as the duration of the lease and the rental amount. While it may seem obvious, it is especially important to specifically identify and designate the portion, or portions, of a property that are subject to the solar lease if a landowner is retaining certain other portions of the property for its own use. Thus, simply identifying the property by a legal description, tax identification number, or common street address may not be appropriate as it could inadvertently cover the entirety of the property. A survey may be necessary to specifically identify the portion of land that is subject to the lease.
In certain instances, the landowner may still retain rights to use the portion of the property that is subject to the solar lease for other purposes, such as certain farming operations. If the land is also being used for farming operations, the landowner should make sure that any specific restrictions or limitations on use of the property are outlined. For example, the landowner may be growing organic crops and may want to specifically prohibit the lessee from spraying any chemicals or pesticides anywhere on the property. The landowner should also ensure that the lease prohibits any hazardous materials from being released or discharged upon the property. Farmers should also be careful to comply with the terms of any farmland development rights agreement covering the property and any requirements imposed by the Michigan Department of Agriculture and Rural Development. If the property is subject to such an agreement, Michigan law imposes several requirements that must be complied with and must be addressed in the lease.
Because there is a significant up-front cost involved in building out the infrastructure and installing the solar panel system, it can take many years to achieve a financial return on investment. Accordingly, most solar leases have initial terms that are in the range of 20-40 years, and there may also be renewal options. Solar companies may also want to negotiate for an early termination provision in the lease in the event circumstances change or the site fails to provide an adequate financial return. Alternatively, the solar company may want to sign a shorter initial term (perhaps 5 years) and obtain a larger number of options to renew so that the company is not locked in for too many years of rent if the project is unsuccessful. Landowners can try to negotiate an early termination fee to account for some lost rental income if the solar company is terminating the lease early.
Landowners should also be aware that property taxes may increase once a solar lease is signed depending on the length of the lease or the terms of any option to purchase the land at the expiration of the lease. Under the Michigan General Property Tax Act, a lease with a total duration, including the initial term and all options for renewal, of more than 35 years, or which grants the lessee a “bargain purchase option” is considered a “transfer of ownership” and will cause a property tax “uncapping” for the current owner of the land.
Due to the long-term nature of solar leases, it is important to account for rental increases during the lease term. Rental increases will be necessary to keep up with inflation since the fair market rental amount today is likely much less than the fair market rental amount 10-20 years from now. Some landowners/developers may prefer to build in annual increases in rent in the range of 2%-3% per year as this will provide certainty as to how much rent is collected each year. Other landowners/developers might prefer to tie the rental increases to the Consumer Price Index[1] so that the percentage of increase is more accurately reflected by market conditions.
Solar leases can be structured as a “gross” lease (where the solar company pays a flat dollar amount each month/year for the use of the land), some form of a “net” lease (where the solar company pays a base rental amount and also reimburses the landowner for certain expenses like property taxes and insurance), a “percentage” lease (where the rental amount is tied to the amount of energy generated by the solar company), or any combination thereof.
The solar energy system and related equipment are typically retained as personal property owned by the lessee. Thus, the solar company typically has the right to remove such property from the land at the termination of the lease. As additional security for the payment of rent, the landowner may want to consider asking the tenant to grant the landlord a security interest in this personal property (if it is deemed valuable). If a security interest is being granted, the lease should specify that the parties will file a UCC financing statement giving the landowner a security interest in the system which could potentially be re-possessed if the solar company defaults under its payment obligations.
Solar leases should also address the obligations of the solar company to ensure that no construction liens are recorded against the property throughout the course of any work performed by the lessee. In addition, the landowner will want to make sure that the lessee is responsible for the restoration of the property and removal of trash and debris at the end of the lease. Standard lease requirements related to insurance and indemnification should also be addressed in a solar lease.
A different concept of solar leases also exists on a smaller scale and is more popular in states in the southwestern part of the Country. These types of leases involve homeowners (or business owners) signing a lease with a solar panel company that installs the system onto the roof of the building. The solar panel company incurs the up-front cost of materials and installation of the system and then charges the homeowner for the energy that is produced at a lower rate than the typical utility company. The property owner is required to sign a lease for a period of time that is long enough to ensure that the solar panel company generates a sufficient return on investment. These leases are often in the range of anywhere from 10-25 years, and the homeowner may have an option to purchase the system at the end of the lease or renewal options.
The items addressed in this article are merely a sampling of some of the most important things to look for when negotiating a solar lease. There may be other important provisions to be aware of and to negotiate depending on the specific circumstances of each transaction. Whether you are a landowner, a developer, or a business interested in solar leasing, you should retain experienced legal counsel to protect your interest when negotiating a solar lease.
Brandan A. Hallaq is a Senior Attorney with Hirzel Law, PLC where he litigates cases involving defective construction, contract disputes, shareholder/member disputes, quiet title actions to determine interests in property, enforcement of restrictive covenants, real estate foreclosure actions, and bankruptcy matters representing creditors. Mr. Hallaq is also a licensed Real Estate Broker in the State of Michigan and leads the real estate transactions department at Hirzel Law, PLC where he negotiates and prepares the necessary documents for business and real estate transactions, including purchase agreements, franchise agreements, loan/financing documents, and commercial and residential leases and mortgages. In each year from 2018 through 2021, he has been recognized as a Rising Star in the area of real estate law by Super Lawyers Magazine, a designation that is given to no more than 2.5% of the attorneys in the State of Michigan each year. He was also recognized as a 2020 Up & Coming Lawyer by Michigan Lawyer’s Weekly, an award given to no more than 30 attorneys in the state each year, and he was recognized in the inaugural issue of the 2021 Best Lawyers in America: “Ones to Watch” list for professional excellence in real estate law. Mr. Hallaq obtained his Juris Doctor degree, cum laude, from Wayne State University Law School where he served as an editor on the Wayne Law Review. Prior to joining Hirzel Law, PLC, Mr. Hallaq worked for a Federal Judge and in a Fortune 500 corporation’s in-house legal department. He can be reached at (248) 478-1800 or at bhallaq@hirzellaw.com.
[1] According to the United States Bureau of Labor Statistics, “The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
