Energy development contracts commonly permit landlords (on whose land the energy project is constructed) a buyout right with respect to the project, often for a nominal payment… but that right isn’t guaranteed in the event of the developer’s bankruptcy.
Section 365 of the Bankruptcy Code allows a debtor/trustee to reject executory contracts that in its business judgment are burdensome. To the extent an energy development contract is executory in nature (i.e., mutual obligations exist under the contract), the debtor/trustee can reject the contract, thereby effectively terminating the landlord’s buyout right. If the debtor/trustee can realize more value by selling the project assets to a third party, it will do so because of its obligation to maximize the value of the assets of the bankruptcy estate. In this scenario, the landlord will be left with nothing more than a contract rejection damage claim to be filed against the bankruptcy estate, which in many cases will be paid out at cents on the dollar, if at all. Even in circumstances where the contract cannot be or is not rejected, the court may find the buyout right unenforceable.
A landlord can potentially protect itself from that outcome by implementing contract drafting strategies to increase the chances of preserving its buyout right in the context of bankruptcy. Two such strategies are to include (1) an option to purchase the project assets at their fair market value (thus ensuring the bankruptcy estate receives fair market value for those assets, versus a lesser nominal payment that a bankruptcy court is likely to find unsatisfactory) and/or (2) a right of first refusal (in which any third-party offer to purchase the project assets is presented to the landlord, who can then purchase those assets by matching that offer – ensuring the bankruptcy estate receives the highest possible price for the assets while protecting the landlord’s ability to purchase them). The second option may prove more appealing than the first… third-party offers from parties without plans to take over the project in situ will take into account the cost of the assets’ removal, transportation, and reassembly, such that they may be less than the fair market value an independent appraiser would provide (resulting in a windfall to the landlord).
There is no guarantee that a bankruptcy court will enforce such rights, but because such rights don’t conflict with a bankruptcy policy goal (i.e., maximizing the value of the bankruptcy estate’s assets), they are much more likely to be enforceable than the typical contract term (i.e., an option to purchase project assets for a nominal payment). Unfortunately, there are no definitive answers and results will be highly fact specific and determined on a case-by-case basis.
Accordingly, landlords should be aware of the risks associated with buyout provisions if developers later file bankruptcy and take steps to mitigate those risks when drafting energy project development contracts.
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