In many discussions of community solar, developers express great interest in the business model but also note that uncertainty about the still-evolving legal and regulatory framework is holding them back from pursuing projects. As a result, we spoke with attorneys Darin Lowder and Katie Leesman of Ballard Spahr LLP about some of the legal and regulatory challenges that face developers in trying to develop and finance community solar gardens.

Stratton Report: What states have the most developed legal and regulatory frameworks for community solar?

Darin Lowder: In Colorado and Massachusetts we have seen community solar deals closed that have been debt financed or financed with tax equity, so I’d say those programs are farther along. But even there you can see uncertainties in the process. About a year ago we were representing a developer in Colorado and we were speaking to the regulatory counsel from his tax equity provider, talking through the status of an agreement with the utility recognizing this project as an approved community solar garden that was subject to the program requirements and that could qualify for the bill credits and so on. At that point the tax equity was ready to finance the project but that critical agreement was still unsigned. According to the Colorado program guidelines, the agreement gets signed at step four, and we hadn’t gotten to step four yet. Their counsel wanted to know if the utility was actually obligated to sign the agreement, or not. So we had to give some comfort about that, which wasn’t trivial to do because there were very few projects that had been financed at that point. So things are always a bit uncertain when you are dealing with programs in their early days.

Katie Leesman: The Minnesota community solar program is also pretty far along, but it’s a work in progress. There was just recently a PUC meeting to decide whether to clarify eligibility for Xcel’s community solar program. The rules are pretty far along, but there are still potential tweaks that might be made.

Stratton Report: I was surprised to see how many community solar projects had applied for official status in Minnesota, but it seemd that relatively few had been approved.

DL: And community solar projects have to put up a significant deposit as I recall in Minnesota. You couldn’t just sign up for free. You had to put cash down to get in line.

KL: That being a contentious issue in Minnesota – the PUC has been battling with and trying to put more strict requirements on Xcel in terms of the processing timeline and the interconnection timeline.

Stratton Report: So are any new states moving towards well-developed programs?

KL: Probably the closest is Maryland, which published draft regulations on April 29, and is holding a rulemaking session on June 14 to determine whether to adopt the draft regulations. After the final regulations are issued, the utilities will have to file their programs with the PUC and get approved from the commission itself. And at that point developers could start submitting their program applications.

Stratton Report: Has there been any litigation to clarify legal questions about community solar programs?

KL: I’m not aware of any litigation to date.

Stratton Report: What is the most contentious aspect of community solar in regulatory proceedings?

DL: I would say utilities are cautious about the bill credit amount—really, the price the utility pays for the electricity that the community solar garden generates. In some states the utility is obligated to give a bill credit at retail rates. And in some states that’s discounted by some kind of system charge and other states it’s not. So if you’re a utility you could see the concern over having to compete with community solar, especially if you are providing a full retail credit that doesn’t account for system charges. Utilities are wary of that and are trying to influence the shape of the regulations.

Stratton Report: Is it clear how to account for all the benefits and costs of community solar? That could get very complicated.

DL: In California the community solar program is encumbered with a lot of charges and the bill credit is calculated by a very complicated formula. That makes it very hard to explain what the end rate is going to be to the customer. Under the current structure we’re not anticipating a lot of deals getting done there because there are places with much clearer and more customer-friendly rules. I expect that the industry will gradually find approaches that will work better, incentivize people and address the sharing of benefits and burdens. I think it will be a similar process to what states went through when they were figuring out net metering, or when they were figuring out how to implement the renewable portfolio standards.

Stratton Report: Is anything is happening in the 35 states that are still without community solar enabling legislation?

KL: Every week we check all the legislative activities for all the states on this topic. And there have been many bills proposed but they usually haven’t made it past the first chamber. I believe there will be more passed, it’s just a matter of time.

Stratton Report: What kind of restrictions are there, if any, on who can be part of a community solar program?

DL: There are usually a minimum number of subscribers that need to be in place. One of the concerns, is to make sure that what is described as community solar, just doesn’t turn into a single customer getting power wheeled for free. So in some states that means a requirement to have two subscribers, you can’t be all on your own. And of course some states require more than two and there can be other issues. When we were talking with real estate developer groups about community solar, they started asking if they could sign up their entire apartment building as the building owner. If the utilities are purchased by the building owner they can do it. If the utilities are purchased by the individuals the tenants can be enrolled as members, if there is an opt-in to a program that the landlord has negotiated for them.

KL: I’ll just caveat that. In some states, for example, they have allowed multi-tenant buildings to be members and get a shared bill credit in a building with a single meter, but you have to have more than just one apartment building as the customer.

Stratton Report: That raises the interesting question of who qualifies as a “customer” in community solar projects. Is it the building owner or the tenants?

: In most states if you have a meter you’re a customer. And so if you’re a customer then you’re under the program and you can be a subscriber. Of course, there are often exemptions from state regulation when landlords are providing power to their tenants so that what looks like the resale of electric power isn’t treated the same.

Stratton Report: I’ve seen some recent reports of large companies becoming members of community solar projects as “anchor tenants” and off-taking large quantities of power. So organizations as well as individuals can be community solar members?

DL: Yes. We have seen a number of examples of that. In some states, there are limits often on what percentage a single subscriber can have from a community solar garden. Within those limits the community solar model can function a lot like an aggregated or virtual net metering structure but there are multiple off takers. But, if you’re a large off taker within those guidelines you can buy a significant amount of power from that project, and you neither have to develop it, nor do you have to put up the upfront capital. So yeah, I do think there are significant opportunities for such participants.

Stratton Report: Speaking of community solar participants, what is their legal status in the project? If they put up money to become members, does that make them investors?

DL: Regulators have asked that question in some states. Community solar projects are pretty careful to avoid having their members appear to be investors, because that would be problematic under the Blue Sky laws. Membership agreements are careful to address this issue by outlining what participants are purchasing and what they’re not –-while the subscription agreement entitles them to a share of the output from the system, what they’re actually purchasing is a credit on their utility bill and they don’t get anything from a resale of the facility. They don’t get things that owners typically get. Developers need to understand federal securities laws, and state securities laws, and to make sure they’re on the right side of both of those.

Stratton Report: Are there specific issues in financing a community solar project that don’t arise in utility-scale or residential solar projects?

DL: The membership portfolio of community solar projects can present unusual challenges compared to other types of solar. A lot of states allow for both residential subscribers and commercial subscribers, but banks don’t usually mix those two groups together in their underwriting. Having said that, of course, in the end the financing structure of a community solar project looks like a lot of residential solar deals in that the developer sets up criteria for the membership portfolio. Residential subscribers need to meet this FICO score and they may need to meet situational criteria as well, as in where they’re located. Are they an owner or a renter?

Stratton Report: How sensitive are lenders to whether the project initially meets its subscription goals?

DL: Most financing entities are going to require that the membership pool be quite fully subscribed before they’ll loan you money. They want to see very high levels of subscriptions. Lenders see benefits to having a diversified subscriber group, because there’s the chance of coordinated churn in that group if the members are too much alike. If your members are all homeowners in a suburban neighborhood, it is possible that a large number of them might move out of utility service territory all at once. So, 95 percent of the output, if not a 100 percent of the output from a diverse group of members may need to be subscribed before the developer can drop the project into the tax equity fund, or before they can draw on a debt fund. And when the developers are allowed to draw on the debt fund it’s often highly discounted. When you’re financing a utility-scale asset by contrast you are borrowing based on both the project revenues and the value of the asset. The lender has access to both sources of repayment typically in that kind of standard project finance model. In this model the lender may have access to the asset, but the asset doesn’t mean anything without the subscribers. Even though they’re replaceable, you need this entire structure to be in place for it to work. Otherwise you’re just going to have a big solar farm in the middle of the field, with no place to sell your power. So, the lender has to be comfortable with that so you can keep your regulatory status as a community solar project.

Stratton Report: Do most community solar projects demand cash up front from their members, or do they finance these membership contributions?

DL: Some projects demand members pay cash up front, but the typical arrangement is to provide financing of those contributions. Keep in mind you’re also explaining to a customer why it’s such a great deal for them. So often a part of that is no upfront payment and you save money on day one. It’s possible to do it the other way, but I don’t think that’s where people are seeing success. Convincing somebody to pay upfront for a credit on their bill that they haven’t yet received from a system that they might never lay eyes on, because it’s somewhere else, is a tough sell.

Stratton Report: So are you excited about the future of this solar business model?

DL: We’re very optimistic that this will be a flourishing area. There is a lot of potential here, because about half the country’s properties are not suitable for rooftop solar. Whether because of the geography or ownership issues, this just opens up access for many more consumers to benefit directly from solar. Community solar can greatly increase the potential solar market. That’s why we’re spending time tracking it and writing about it. I think a lot of education still to do.