20040831Decision Memo.pdf

DECISION MEMORANDUM
TO:COMMISSIONER KJELLANDER
COMMISSIONER SMITH
CO MMISSI 0 NER HANSEN
COMMISSION SECRETARY
COMMISSION STAFF
LEGAL
FROM:SCOTT WOODBURY
DATE:AUGUST 27, 2004
SUBJECT:CASE NOS. IPC-03-16 (Idaho Power);
A VU-03-9 (Avista); PAC-03-13 (PacifiCorp)
MODIFICATIONS TO PURP A CONTRACT SECURITY PROVISIONS
IDAHO POWER PETITION FOR RECONSIDERATION/
CLARIFICATION OF FINAL ORDER NO. 29482
On November 5, 2003 , Idaho Power Company (Idaho Power; Company) filed a
Petition with the Idaho Public Utilities Commission (Commission) requesting authority among
other things to eliminate the second lien requirement as a risk mitigation measure in PURP
Power Purchase Agreements containing levelized avoided cost rates. Staff objected to the
proposed elimination of the second lien requirement noting that without a second lien, PURP A
Qualifying Facilities (QFs) desiring levelized rates must post 35% liquid funds as security for the
calculated overpayment that results from the front-end loading that occurs with a levelized rate
structure. Idaho Power in reply comments represented that should the Commission continue
with the second lien requirement the Company intended to outsource the legal work and
requested that it be permitted to collect the estimated $1 000-500 cost directly from the QF or
alternatively recover the lien expense as part of its annual Power Cost Adjustment (PCA) filing.
Addressing this issue of cost recovery, Staff contended that this was a contract administration
cost and has never been a cost directly billed to QFs; nor was it the type of power cost that was
appropriate for recovery through the PCA. Staff opposed the direct billing of this cost to QFs or
the recovery of same through the PCA.
On April 27, 2004, the Commission issued final Order No.29482 in Case
Nos. IPC-03-, A VU-03-, and PAC-03-13. In its Order the Commission denied Idaho
DECISION MEMORANDUM
Power s request to eliminate the second lien requirement as a risk mitigation measure for
PURP A Power Purchase Agreements containing levelized avoided cost rates. For new levelized
contracts the Commission authorized the Company to recover its lien expense from the
contracting QFs; or alternatively, permitted a QF to prepare the lien documentation and file the
lien itself.
On May 17, 2004, Idaho Power filed a Petition for Reconsideration (IDAP A
31.01.01.331) or in the alternative a Petition for Clarification (IDAP A 31.01.01.325) regarding
the portion of Commission Order No. 29482 that provides the option for QFs to prepare and file
the lien or security interest documentation. The specific Order language of concern to the
Company is the following:
The Commission continues to find value for ratepayers in the presence of a
second lien to secure overpayment liability. We recognize that securing a
lien may entail some expense. We assume the Company s decision to
outsource is based on determination that the utility has no in-house
expertise or that the cost of outsourcing the task is less than performing the
task itself. The Commission finds that it is inappropriate to recover this type
of expense as part of the Company s PCA. We find it reasonable, however
for the Company to assess this cost to QFs. Alternatively, we find
reasonable that the QF be permitted to prepare the lien documentation and to
file the lien itself. The procedure that we approve for recovery of lien
expense is for new levelized PURP A contracts only.
Order No. 29482, p. 12.
Idaho Power states that it understands the Commission s desire to minimize QF
transaction costs, however, the Company is concerned with the conflict of interest created by
allowing QF developers to prepare and file the documents needed to secure Idaho Power
security interest in the assets of their respective QF projects. Idaho Code, Title 28, Chapter 9
the Company notes, sets out very precise documentation and filing requirements to protect
security interests. If the requirements are not filed precisely, the security interest is not perfected
and is subject to attack in the event of competing creditors seeking to foreclose on the QF'
assets. The QF's failure to correctly document, perfect and maintain its security interest in QF
project assets would jeopardize the Company s ability to maintain a priority creditor position on
the assets covered by the security interest.
Idaho Power maintains that QF developers do not have a proper incentive to do a
thorough job of creating and perfecting Idaho Power s security interest. If the Commission still
DECISION MEMORANDUM
desires to provide this option to QF developers, Idaho Power requests that the Commission
clarify Order No. 29482 by requiring that QF developers electing to prepare and file the lien
documentation must permit the Company to review and approve all aspects of the creation of the
security interest.The Company also requests that the Commission clarify that if the QF
exercises this option to self file, Idaho Power will have no obligation to take remedial steps if the
QF developer fails to adequately cover all project assets or fails to file any required continuation
statements to maintain the viability of this security interest over the full-term of the contract.
Idaho Power notes that the recommended review and approval procedure of the
second lien documentation prepared by QFs will require the Company to incur additional legal
expense. Nevertheless, Idaho Power believes the initial review and approval by Idaho Power is
necessary to at least reduce the likelihood of potential problems if a QF project experiences
financial problems.
Of further concern to the Company, the Commission s final Order No. 29482 also
contains the following language:
. . .
For existing levelized PURP A contracts, the Company is expected to
administer its contracts in a responsible fashion and to require QF compliance
with Commission -292 security requirements. For those levelized QF
contracts without a second lien, the QF should be brought into compliance or
the Company should require a posting of liquid security. The Commission
expects the Company to follow Commission Orders. Reference Idaho Code
9 61-706. If liquid security is required but not enforced, it is the Company and
not its customers that are at risk for the foregone security.
Order No. 29482, p. 12.
Idaho Power believes that it is unreasonable for the Commission to require the Company to
accept a security interest created by the QF developer and then put the Company at risk if those
security interests are not enforceable or do not cover all of the assets associated with a QF
project. If the Commission gives QF developers the option to prepare and file the documents
needed to perfect Idaho Power s security interest in the QF's assets, the Company believes that it
should be relieved of any liability, even if it has review and approval authority, if it is ultimately
determined that the security interest provisions of the Commission s -292 security requirements
do not cover all of the QF assets or cannot be enforced.
DECISION MEMORANDUM
On June 9, 2004, the Commission issued Order No. 29515 granting reconsideration
and establishing a schedule for comment. As part of its reconsideration, the Commission noted
that its seminal decision to authorize recovery from QFs of Company legal expenses related to
second liens is also at issue.
Comments were filed by Idaho Power, A vista and Commission Staff. The comments
can be summarized as follows:
A. Second Lien Requirement - QF Option to Self-Perfect
Idaho Power
On Reconsideration Idaho Power presents two alternative options:( 1) that the
Commission eliminate the self-perfection option; or (2) provide Idaho Power the right to review
and approve the QF's documentation and perfection option.
For either a first or a second lien to have any value, upon default, the lien holder
Idaho Power contends, must be able to step into the shoes of the QF developer-owner as soon as
possible and take over operation and maintenance of the project. Property involved in the QF
project generally involves several different types of property, i., real property, fixtures
personal property, and other property such as property and equipment leases, fuel supply
contracts, easements, rights-of-way, etc.
In Order No. 29482, the Commission stated its assumption that the Company
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, the Company
states, were correct. Secured transactions involve specialized areas of the law that are constantly
changing. Another major part of secured transactions laws is the effect of bankruptcy on loan
security. Bankruptcy law, the Company states, is a very specialized legal practice and missteps
often lead to loss of priority. 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 a prudent course to follow to protect the interest
both the Company and its customers.
Allowing the QF developer to self-perfect the second lien, Idaho Power contends
presents a conflict of interest. Idaho Power understands the Commission s desire to reduce the
DECISION MEMORANDUM
transaction cost to the QF 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 QF the option to document, prepare and perfect a second priority security interest to
attach 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 QF's interest 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 on the date and time of
filing/recording. Idaho Power is concerned that allowing QF developers to control the
filing/recording of these security instruments may further jeopardize Idaho Power s position.
Unfortunately, the Company states, the only time the quality of QF developer self-
perfected second lien interest will be truly tested is when the QF project has defaulted. When the
QF fails to perform the requirements of the Firm Energy Sales Agreement, 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 and times, 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. If the lien is improperly documented or perfected or 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.
If the Commission does not eliminate the QF self-perfection option, at a minimum
Idaho Power states, that it should be permitted to review and approved the second lien
instruments and confirm that the second lien interest was properly perfected in accordance with
Idaho law and in a timely manner. The Company requests that the Commission bear in mind
that this option will essentially double the legal expense associated with second lien transactions.
The QF will be required to pay its legal counsel to prepare the second line documents and Idaho
Power will be required to pay its legal counsel to review and approve the second lien documents.
DECISION MEMORANDUM
Commission Staff
Staff concludes that the -292 Second Lien Security Requirement is not broken, continues
to be of value and requires no elimination, adjustment, modification or fix. Staff recommends
that the Commission rescind its earlier decision to permit QFs to self prepare and perfect second
liens. Staff in comments notes that in response to a production request the Company identified
25 projects with levelized rates that are subject to the Commission s -292 Second Lien Security
Requirements. All of the projects with the exception of one have an existing and filed second
lien. The one exception elected to post liquid security in the form of a letter of credit. Staff
concludes that the -292 Second Lien Security Requirement was not broken, continued to be of
value and required no elimination adjustment, modification or fix.
Staff believes that Idaho Power s arguments are compelling for eliminating the QF
option to self-perfect second liens. By not allowing the self-perfection option, Idaho Power can
avoid incurring additional legal expense that would otherwise be necessary for review and
approval of second liens perfected by the QF. In addition, removing the self-perfection option
will alleviate the Company s concern about risk if those security interests are not enforceable or
do not cover all of the assets associated with a QF project.
Avista Corporation
A vista recommends that creation of second liens on QF proj ects be handled in a
manner similar to common commercial and real estate transactions. In those transactions, the
party receiving the benefit of the lien or mortgage may prepare and file the lien or mortgage
documents, or select the attorney or closing agent who performs the required legal work.
other situations, a person or law firm who is neutral to the seller and the buyer performs the legal
work associated with creating the lien. Although the person whose property is to be encumbered
is responsible for executing appropriate documents, only in the most exceptional circumstances
is that person actually tasked with the responsibility of preparing and filing the appropriate
documents that create the lien. Allowing QF developers to prepare and file the required
documents, A vista contends, would be an unnecessary departure from usual commercial practice.
B. Recovery of Second Lien Legal Expense
Idaho Power
Because QF developers obtain significant financial benefits from rate levelization
Idaho Power believes that it is appropriate for the Company to receive reimbursement for legal
DECISION MEMORANDUM
expenses it incurs to secure the significant loan that rate levelization represents. Idaho Power
states that it has negotiated a favorable rate for legal services associated with perfecting the
second lien on QF assets. Unless the QF is uncooperative or is using some very exotic financing
scheme, the legal expense will be in the $1 000 to $1 500 range.
If the Commission elects the review and approval option, Idaho Power requests that
the Commission acknowledge that the legal expenses that 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 the Company to defer those legal expenses for recovery in a future
revenue requirement proceeding, preferably as a QF purchase power expense in the Company
PCA.
Commission Staff
Regarding cost recovery of legal expenses incurred in preparing and perfecting
second liens, Staff recommends that the Commission rescind its decision permitting Idaho Power
to recover the cost of legal expenses incurred in preparing and perfecting second liens, directly
from QFs, regardless of whether the legal work is performed in-house or outsourced. Staff
contends that the legal expenses of preparing and perfecting a second lien, whether done in-
house or outsourced, is a contract administration cost and has never been a cost directly billed to
QFs. Staff opposes the direct billing of this cost to QFs. The legal costs attendant to securing a
second lien are an operating expense appropriate for consideration in rate case revenue
requirement calculations.
Avista Corporation
A vista concurs that a utility should recover in its rates costs relating to preparing
and/or reviewing second liens. Alternatively, Avista contends that the costs of preparation
and/or review of such liens should be directly reimbursed by the developer.
C. Responsibility for Problems Arising Out of QF Self-Perfected Second Liens
Idaho Power
Idaho Power understands that it is responsible for acting prudently when it
undertakes any action in compliance with the Commission s Orders. However, the Company
believes it is unfair for the Commission to allow QFs to self-perfect security interests in their
own property and then hold the Company responsible if those security interests are not sufficient
DECISION MEMORANDUM
to preserve the validity or priority of the lien. The same holds true, the Company maintains
even if it has review and approval rights.
A vista Corporation
If QF developers are assigned the task of preparing, filing and perfecting a second
lien for a utility, then the utility, A vista contends, should not be held responsible for the viability
of that security. It would be unreasonable, it states, to require a utility to accept a security
interest created by a QF and then hold the utility responsible, if the security interest is not
ultimately effective, enforceable or sufficient to cover all of the assets.
Commission Decision
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. Idaho Power contends that the Company should not be held liable for any
failure or loss of priority of the second lien security interest arising out of the QF self-perfection
of its security interest on its own property on behalf of Idaho Power. Idaho Power maintains also
that it should 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
being paid levelized rates.
Staff recommends that the QF option to self-perfect be eliminated.Staff also
recommends that the utility be denied direct recovery of second lien legal expense from the QF
or through the PCA.
Avista recommends that the QF option to self-perfect be eliminated.A vista
recommends that a utility be allowed to recover in its rates costs related to preparing and/or
reviewing second liens. Alternatively, A vista supports direct reimbursement of such costs by the
QF.
Scott Woodbury
bls/M:IPCEO316 AVUEO309 PACEO313 sw3
DECISION MEMORANDUM