The ability to transfer renewable energy tax credits has created a legal and financial puzzle in renewable energy finance.

Banks, traditionally securing interests in tangible assets, are grappling with the intangible nature of tax credits in project financing. Most transactions that generate these credits involve third-party lending, making them subject to security agreements and financing statements.

The introduction of transferable credits has created a situation where credits may never truly become the seller’s property. This raises intriguing questions about creditor rights and the vulnerability of these credits.

Purchasing these credits creates a new set of challenges regarding how these acquired credits interact with existing creditors and financing arrangements. This complex web of finance and tax law creates unexpected hurdles and legal ambiguities in project financing.

Given how widespread the use of these transfers has become, courts need to recognize that there is a security interest in renewable energy tax credits.

Project developers typically form a limited liability company to own and operate renewable energy facilities, and investors acquire interest in these LLCs to offset their federal tax liabilities. Before 2022, tax investors couldn’t purchase energy tax credits outright and acquired them primarily through flip partnerships and sale-leaseback transactions.

The Inflation Reduction Act of 2022 overhauled the landscape for using energy tax credits by making them transferable in certain circumstances. New investors and nonprofit entities could now participate in the process, as the credits became not only transferable but refundable.

A final rule from the IRS last year allowed project owners to preregister through an online portal, which then creates a registration number when the facility is placed in service. Credits are transferred when the facility owner and the purchasing taxpayer file a transfer election statement with their tax returns for the year in which the facility generates credits.

A typical sales transaction involves a credit purchase agreement that provides payment to the project owner by the buyer around the time the credit becomes available. Credits can be sold to multiple buyers, but once they’re made, the transfer election statement is irrevocable.

That means a credit may not be taken unilaterally by a bank or a judgment creditor from a debtor who generated or purchased a tax credit and then placed it on the bank’s tax return.

Prior to the 2022 tax and climate law, energy tax credits were clearly “owned” by the project owner and never sold. Instead, they were allocated as part of a partnership agreement wherein the buyer and seller were all involved. A default by a project owner was unlikely to affect the ability of a tax credit partner to be allocated its credits.

Transferable credits require a new analysis. The bank could arrange for a credit to be transferred to the bank upon default, at least before a transfer election statement is filed. A provision in a well-crafted security agreement could require this.

Even if a bank successfully secures an interest in a tax credit, the credit buyer is in a far different position than an investor in a flip partnership. If the bank argues that the investor bought the credit subject to a lien, and the transfer election statement hasn’t been filed yet, the bank could force the project owner to transfer the credit to the bank per the security agreement rather than to the credit buyer.

We can’t overstate the importance of noting when the security interest was perfected in the credit—such as when the project was registered, after the construction start date, when the project was placed in service—or when the transfer election statement is filed.

Tax credit buyers, as well as project owner lenders, should be mindful of the attachment or perfection of a security interest in a tax credit. Transferable tax credits may be treated as separate assets subject to a lien, rather than as a byproduct of a project as they have been in the past.

Registering clean energy projects opens the door for transferring renewable tax credits to anyone, so lenders and credit buyers should take steps to ensure another creditor doesn’t assert rights over freely transferable credits. Project owners also should ensure that energy credits they wish to transfer are outside the reach of unsecured creditors.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Harry Teichman is partner with Stinson’s energy, environmental, mining and transportation practice division in Tampa, Fla.

Marshall Kelner is an associate at Stinson in Minneapolis.

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