20040712Comments on Reconsideration.pdf

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BARTON L. KLINE, ISB # 1526
MONICA B. MOEN , ISB # 5734
Idaho Power Company
1221 West Idaho Street
O. Box 70
Boise, Idaho 83707
Telephone: [phone]
FAX Telephone: [phone]
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Attorneys for Idaho Power Company
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF A PETITION FILED BY
IDAHO POWER COMPANY FOR APPROVAL)
OF MODIFICATIONS TO THE SECURITY
PROVISIONS REQUIRED TO BE INCLUDED
IN AGREEMENTS BETWEEN IDAHO
POWER AND CO-GENERATORS
AND SMALL POWER PRODUCERS
CASE NO. IPC-03-
IDAHO POWER COMPANY'
INITIAL COMMENTS ON
RECONSI DERATION
Background
In Order No. 29482 issued in this case on April 27 2004 ("the Order ), the
Commission determined that it would continue to require PURPA qualifying facilities
QF's ) that desire to receive levelized rates to either (1) post liquid security (cash or
cash equivalents) in an amount equal to thirty-five percent (350/0) of the overpayment
liability associated with the levelized rate structure; or (2) allow Idaho Power Company
Idaho Power" or "the Company ) to place a second priority security interest ("second
lien ) on the QF's projects assets.
For new levelized rate QF contracts, Order No. 29482 authorized Idaho
Power to recover its legal expenses associated with preparing and recording
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page
perfecting ) the second priority security interest from the contracting OF's; or
alternatively, the Order permitted the OF itself to prepare and perfect the second lien
that would attach to the OF's property ("self-perfection
Idaho Power filed a timely Petition For Reconsideration , or in the
Alternative, a Petition For Clarification , regarding the portion of Order No. 29482 that
provides the option for OF's to self-perfect the second lien on its own property for the
benefit of Idaho Power.
The Commission granted reconsideration on June 9 2004 and permitted
the Company to file written comments in support of its Petition. In addition to the items
the Company identified in its Petition For Reconsideration, the Commission sua sponte
decided to reconsider its decision to allow Idaho Power to recover from OF developers
the legal expenses the Company will incur to prepare and perfect its second priority
security interest in the OF generating project.
In its Petition for Reconsideration or Clarification , the Company presented
two alternative options: (1) that the Commission eliminate the self-perfection option; or
(2) if the self-perfection option is retained , Idaho Power would have the right to review
and approve the OF's documentation and perfection process.
In granting reconsideration in Order No. 29515, the Commission did not
identify which of the two above-described options on which it desired to receive
comments. Therefore, Idaho Power will address both options. Idaho Power will also
explain why it believes it is fair for the Company to receive reimbursement of the legal
expenses it incurs in preparing and perfecting the second priority lien that will attach to
the OF facility.
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION , Page 2
Levelized Rates Are A Loan From
Customers To QF Developers.
The Commission has previously determined that paying OF's on a
levelized basis is in the public interest because it encourages the development of OF
projects. Levelized payments involve paying the OF a price that exceeds the utility
projected avoided cost in the early years of the term of the Firm Energy Sales
Agreement ("FESA") and paying the OF rates that are less than projected avoided costs
in the later years. The stream of payments, on a present value basis, is computed to be
financially equivalent to the unlevelized avoided cost purchase prices. The Federal
Energy Regulatory Commission ("FERC") rules governing the setting of OF rates
specifically authorized state commissions to use levelized rates in setting avoided costs.
(18 CFR ~ 292.304(b)(5)).
Paying levelized rates to OFs means that the Company and its customers
are making long-term loans to the OF developers. For large OF projects, this loan can
be tens of millions of dollars.Rate levelization also allows the QF developer to
improve its cash flow and allows the QF developer to utilize a higher amount of
leverage , i.e., use more debt than equity in putting together its project.
If the OF project successfully completes the full term of the FESA
customers are indifferent. If the QF does not successfully complete the full term of the
FESA and the QF is unable to repay the loan created by the payment of levelized rates
When Boise Cascade closed its Emmett OF facility and terminated its FESA with Idaho Power
Boise Cascade paid Idaho Power $4 million to repay the overpayment liability associated with its
receipt of levelized rates.
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION , Page 3
Idaho Power s customers can be disadvantaged. This is why the Commission has
ordered QFs to provide security for overpayment liability.
It's also important to note that in most instances , QF projects are
developed on a "project finance" basis. The OF developer creates a single-purpose
entity to own the QF project and the FESA with Idaho Power provides most of the credit
support for the project loan. As a result, there is usually no recourse to any assets other
than the generating project itself. The first priority secured interest lender can negotiate
other security arrangements as a condition of making its loan to the QF developer.
Commission Order, Idaho Power is limited to either the 35 percent liquid security
deposit or a second priority security interest. Not surprisingly, no QF project of any size
has ever offered to post the cash deposit to avoid the second lien requirement.
II.
Perfecting and Maintaining A Valid Second Priority
Security Interest Is A Complex Legal Process.
To better understand Idaho Power s concern with giving the QF developer
the right to self-perfect a second priority security interest on its own property, on behalf
of Idaho Power, it's important to briefly discuss what is involved in obtaining a security
interest in property.
For either a first or a second lien to have any value , upon default, the lien
holder must be able to step into the shoes of the OF developer-owner as soon as
possible and take over operation and maintenance of the project. Property involved in a
QF project generally involves several different types of property. As described below
each type of property requires a different legal process for obtaining a security interest
in that property.
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page 4
Real Propert
A security interest in real property generally involves either a mortgage or a
deed of trust. Mortgages and deeds of trust are separate and distinct security
instruments , each with its own statutory and contractual requirements and with very
different methods of foreclosure. Recognizing that real property is the largest asset
many people ever own , the law governing foreclosure of mortgages and deeds of trust
requires strict adherence to all of the notice and other requirements set out in the Idaho
Code. Idaho case law is replete with situations where the secured creditor s failure to
precisely follow the statutory requirements , as those requirements have been
interpreted by multiple court decisions, ultimately resulted in loss of priority and failure of
the secured creditor to obtain the relief it expected to receive at the time it loaned the
money to the debtor.
Fixtures
This is a hybrid between personal property and real property for certain
types of equipment that is affixed to real property. Turbines, generators and power
poles are all examples of fixtures. Fixtures have their own unique documentation and
perfection procedures specified' in Title 28, Chapter 9 , of the Idaho Code.
Personal Property
This is property that is neither real property nor fixtures. Title 28,
Chapter 9, of the Idaho Code generally governs the creation and perfection of security
interests in this type of property. The requirements for filing and perfecting a security
interest in personal property are specific and failure to precisely follow all the steps will
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION , Page 5
result in the security interest losing its priority or not being enforceable in a bankruptcy
proceeding.
Other Property
In addition to the three types of property described above, almost every
OF project involves other kinds of property or rights that must also be addressed if the
first or second lien holder is going to have any chance to realize value from its security
interest in the event of the default by the OF developer. These would include property
anQ equipment leases, fuel supply contracts , easements, rights-of-way and a myriad of
other miscellaneous contracts and interests in property.
III.
The Company Will Use Outside Legal Counsel
To Prepare Security Interests For QF Projects.
In Order No. 29482 , the Commission stated its assumption that the
Company s decision to outsource the preparation and perfection of its second lien was
based either on a determination by the Company that it was not comfortable using its in-
house legal counsel to prepare and perfect QF second liens or a determination by the
Company that the cost of outsourcing the task was less than performing the task itself.
Both assumptions were correct.
Secured transactions involve specialized areas of the law that are
constantly changing. The Idaho legislature recently made numerous changes to the
laws governing secured transactions in the state of Idaho.
Another major part of secured transactions law is the effect of bankruptcy
on loan security. Bankruptcy law is a very specialized legal practice and missteps often
lead to loss of priority.
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page 6
For all of these reasons, the Company has concluded that outsourcing the
legal work associated with QF second liens to legal counsel that specialize in secured
transactions and bankruptcy law is the prudent course to follow to protect the interests
of both the Company and its customers.
It should be noted that first priority lenders almost always include the costs
they incur for legal fees as a cost of QF loan transactions. The QF developers pay the
first lien holder s legal expenses directly or as additional principal. Because
developers obtain significant financial benefits from rate levelization, Idaho Power
believes it is appropriate for it to receive reimbursement for legal expenses the
Company incurs to secure the significant loan that rate levelization represents. Idaho
Power has negotiated a favorable rate for legal services associated with perfecting the
second lien on the QF assets. Unless the QF is uncooperative or is using some very
exotic financing scheme, the legal expense will be in the $1 000 - $1 500 range.
IV.
Allowing the QF Developer To Self-Perfect The
Second Lien Presents A Conflict of Interest.
The process of preparing the necessary security instruments and
perfecting the second lien security interest to attach to the various types of property
usually associated with the QF facility is complex. Idaho Power understands the
Commission s desire to reduce the transaction costs to the OF associated with the
second lien process. It is not Idaho Power s intent to make the process more
complicated or more expensive than is reasonably required to protect the Company and
ultimately its customers. That being said , Idaho Power is concerned that giving the OF
the option to document, prepare and perfect a second priority security interest to attach
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION , Page 7
to the QF's own property, presumably on behalf of Idaho Power, presents an inherent
conflict of interest. Mortgages, deeds of trust, and security agreements often include
notice provisions, default provisions , representations , warranties and definitions that
could place the drafting OF's interests at odds with those of Idaho Power. Security
instruments deemed adequate by a debtor may justifiably be viewed as deficient by a
secured creditor. Moreover, the priority of a security interest perfected by filing or
recording, as is the case with security interests in real property, fixtures and most
personal property, depends in large part upon the date and time of filing/recording.
Idaho Power is concerned that allowing QF developers to control the filing/recording of
the security instruments may further jeopardize Idaho Power s position.
Unfortunately, the only time the quality of the QF developer s self-
perfected second lien interest will be truly tested is when the QF project has defaulted
and all of the creditors are fighting over the assets of the failed QF project.
When the QF fails to perform the FESA , defaults on various loans and
other credit arrangements can occur. In that event , the filing of additional liens by other
creditors, the filing of foreclosure actions associated with those liens, and ultimately the
filing of bankruptcy by the QF are distinct possibilities. At any of those points in time
the validity of all of the liens is closely examined by the creditors , the bankruptcy trustee
and others who have an interest in having higher priority security interests set aside so
that their particular debt is more likely to be paid.
This is when the second lien prepared by the QF developer on behalf of
Idaho Power will be scrutinized very closely. Inevitably, one of the other creditors will
argue that it should lose its priority. If the lien is improperly documented or perfected or
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page 8
maintained and is set aside , or if its priority is compromised , the bankruptcy trustee and
other potential junior creditors, including any equity participants in the QF project, will
benefit.
Of course , at that time Idaho Power s prior ability to demand 350/0 liquid
security or declare a breach of the FESA if the OF does not post the required 350/0 liquid
security is a worthless contract right. If the QF project has reached that level of
distress, it is very unlikely that other assets exist to satisfy the overpayment liability
owed by the QF to Idaho Power. Allowing the QF developer to self-perfect presents a
basic conflict of interest. The equity owners of the OF could actually benefit if the
second lien is defective. The small savings in legal expenses for the QF is simply not
worth the risk.
In its Petition , the Company presented an alternative for the Commission
consideration. The Company noted that if the Commission still desired to give OF
developers the option to self-perfect the second lien on the property on behalf of Idaho
Power, at a minimum , Idaho Power should be permitted to review and approve the
second lien instruments and confirm that the second lien interest was properly perfected
in accordance with Idaho law and in a timely manner. While Idaho Power bel.ieves this
is still a potential option the Commission should consider, the Company requests that
the Commission bear in mind that this option will essentially double the legal expense
associated with second lien transactions. Undoubtedly, the QF will be required to pay
its legal counsel to prepare the second lien documents and Idaho Power will be required
to pay its legal counsel to review and approve the second lien documents. If the
Commission elects this review and approval option , Idaho Power requests that the
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION , Page 9
Commission acknowledge that the legal expenses Idaho Power incurs to review and
approve the documents prepared by the QF are not unusual or one-time expenses and
the Commission should authorize Idaho Power to defer those legal expenses for
recovery in a future revenue requirement proceeding, preferably as a QF purchase
power expense in the Company s Power Cost Adjustment.
Idaho Power Should Not Be Held Responsible For
Problems Arising Out of QF Self-Perfected Second Liens
On page 12 of Order No. 29482 , the Commission cautions the Company
that if the Company fails to enforce QF compliance with the Commission s security
requirements , it will be Idaho Power and not Idaho Power s customers that will be at risk
for the foregone security. Idaho Power understands that it is responsible for acting
prudently when it undertakes any action in compliance with the Commission s orders.
However, Idaho Power believes it is unfair for the Commission to allow QF's to self-
perfect security interests in their own property and then hold Idaho Power responsible if
those security interests are not sufficient to preserve the validity or priority of the lien.
If the Commission believes it is in the public interest for QF developers to
have the option to self-perfect, then it should also acknowledge that it is inequitable to
hold the Company responsible for the QF developer s actions. It would be particularly
egregious for the Commission to hold the Company responsible for the validity or
priority of a second lien security interest when the QF developer may be economically
advantaged if the second lien is invalid or if its priority could be set aside as a result of
errors or delay by the QF in perfecting the security interest.
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page 10
While giving Idaho Power the right to review and approve the security
documents and the perfection process is an improvement over the self-perfection
option, it still does not give Idaho Power the degree of control over the process that
should impose liability on the Company. Review and approval is definitely of lesser
value than performing the actual preparation and perfection. The Company believes
that it would also be unfair to hold Idaho Power responsible for an inadequate second
priority lien if it only has review and approval authority.
Conclusion
Based on the foregoing, Idaho Power requests that the Commission
(1) eliminate the self-perfection option created in Order No. 29482; or (2) alternatively,
allow Idaho Power to review and approve the security interest documentation and
perfection process as a condition of contract compliance on the part of the QF.
Under either scenarios (1) or (2) above, the Company should not be held
liable for any failure or loss of priority of the second lien security interest arising out of
the OF's self-perfection of the security interest on its own property on behalf of Idaho
Power. Idaho Power should also be permitted to recover from the QF developer legal
expenses it incurs in developing and perfecting the second lien security interest
required as a condition of the QF being paid levelized rates.
DATED at Boise , Idaho , this 9th day of July, 2004. '
I~~
BARTON L. KLINE
Attorney for Idaho Power Company
IDAHO POWER COMPANY'S INITIAL COMMENTS ON RECONSIDERATION, Page
CERTIFICATE OF SERVICE
I HEREBY CERTIFY that on this 9th day of July, 2004, I served a true and
correct copy of the within and foregoing IDAHO POWER COMPANY'S INITIAL
COMMENTS ON RECONSIDERATION upon the following named parties by the
method indicated below, and addressed to the following:
Scott Woodbury
Deputy Attorney General
Idaho Public Utilities Commission
472 W. Washington Street
O. Box 83720
Boise, Idaho 83720-0074
Hand Delivered
S. Mail
Overnight Mail
FAX [phone]
BARTON L. KLINE
CERTIFICATE OF SERVICE