Property Assessed Clean Energy (PACE) loans allow property owners to finance clean energy improvements to their properties generally secured by property liens senior to mortgages through tax assessments.  Moody’s recently released a special comment expressing some concerns and not-so-subtle hints that it thinks that lenders and securitizers should take PACE programs seriously.

Commercial PACE programs are currently small, but growing.  PACE loans are generally structured as a tax lien and allow property owners to finance (mainly) clean energy property improvements such as the addition of solar panels to a building over a period of up to twenty years.  As of September 2014 more than 260 commercial PACE projects totaling $83 million have been financed nationally.  The largest PACE loan was for $7 million on the Los Angeles Hilton Hotel.  Another $300 million worth of project applications are pending.

Obtaining a PACE loan without the lender’s consent would likely violate standard provisions in CMBS loan documents.  Voluntarily taking on a new obligation to pay an additional tax likely runs afoul of the usual negative covenants in CMBS loan documents which prohibit property owners from incurring additional indebtedness without the lender’s consent.  Putting a new lien on a property is arguably a non-permitted transfer, since that lien creates an encumbrance on the property and most CMBS loan documents define “transfer” to include encumbrances.

The Moody’s special comment advises that the restrictions in some CMBS loans may not be enough to completely prohibit PACE loans.  Generally, tax liens are defined as an allowable lien when not presently due and payable.  Some property owners could argue that the PACE loan should be characterized as an allowable lien and not a loan so long as they keep current on it.

One simple solution to avoid this potential ambiguity would be to explicitly cover PACE loans and their ilk in the loan documents.  Concepts such as “Additional Indebtedness” and “Permitted Encumbrances” should contemplate prohibiting PACE loans.  Guaranties and SPE organizational documents should be drafted accordingly.

Unfortunately, there are some state specific issues with PACE loans which thwart this one-size-fits-all approach.  For example, Moody’s special comment says that Florida’s PACE Statute is particularly concerning.  Regardless of the documentation evidencing the mortgage loan, this statute provides that a lender’s consent for a PACE loan is only required if the PACE loan exceeds twenty percent of the appraised value of the property.  For smaller PACE loans the property owner is only required to give the lender notice.  Moreover, the Florida PACE Statute provides that any provision which accelerates a mortgage loan solely as a result of the property owner obtaining a PACE loan is unenforceable.  Moody’s also cites a commentator who suggests that “bad boy” recourse carve-outs for taking on an involuntary lien could be unenforceable as well.  Note, however, that these potential outcomes are not certain as we are not aware of any court cases interpreting the Florida PACE Statute.

If you want more information on PACE loans, Dechert has previously examined residential PACE programs: here and here.