Residential Solar and the Uniform Commercial Code: A Primer on Solar-Financiers’ Rights in a Home Foreclosure

Travis Lowder's picture

U.S. residential solar PV has been growing at a breakneck pace. Annual installations have increased nearly five-fold in the past five years and, in 2014, surpassed annual commercial capacity additions for the first time in the history of PV market tracking. Additionally, nearly a third of the entire solar industry's workforce—comprising over 174,000 employees—works in residential solar [1, 2, 3].

Consistently high growth notwithstanding, residential solar remains something of a new phenomenon, and several industries are still trying to understand what it means for their businesses. One question being asked by housing regulators, mortgage bankers, ratings agencies, and others is: how do security interests in solar assets affect the claims in the case of default? And what rights do solar financiers have with regard to mortgage holders?

This article will address these questions, but will first provide some background on the Uniform Commercial Code (UCC), a critical piece of the puzzle. If you are already familiar with the workings of the UCC, then it may be best to skip to the section on "Why It Matters."

Security Interests and the UCC

Many solar financiers today offer at least the following three products: leases, power purchase agreements (PPAs), and loans. The first two are third-party ownership (TPO) products—i.e., ownership of the system remains with the financier and the customer pays a monthly sum (fixed or dependent on energy production) to access that system. In a loan arrangement, the customer owns the system and remits to the financier a monthly payment of principal and interest to pay down the debt.

To protect themselves against customer defaults and other credit events, financiers will commonly take a security interest in the solar system that they have financed. In addition, they officially give notice of their rights to the system (the collateral) so that they may legally take possession of it if the customer breaches its contract (and so that another financier cannot). In the case of TPO, the financier already owns the system, but will usually take a security interest and file a financing statement to give notice of its position, just the same as it would for a loan.

Financiers can take security interests as per the UCC, which is a set of legal rules for creating and enforcing rights in property subject to sales, leases, loans, and other types of transactions. Because all states have adopted the code, it serves as the overarching legal framework for commercial/financial transactions in the United States.

A financier can receive a security interest if the debtor has rights In general, financiers can "perfect" their security interest in collateral—that is, to make it effective against competing claims from other creditors—by filing a UCC-1 Financing Statement [4]. They will typically do this with the secretary of state where the borrower is located, at which point the filing serves as the notice of lien to all interested parties. A financier may also choose to file a UCC-1 in the real property records (usually through the county clerk) because this gives an added layer of protection, and because solar collateral could be considered a "fixture" under state real estate law—more on this in the next section.

Additionally, Section 9-103 of the UCC allows lenders a special type of security interest known as a "purchase money security interest" (PMSI). A PMSI arises where money from a loan is used to purchase the collateral for that loan. In other words, if a borrower will be using a loan to purchase a solar system, the lender would want to take a PMSI in that solar system as per the UCC. PMSIs have the distinct advantage of prioritizing the filer over all other lienholders on the asset. That means that the PMSI-perfected lender has first rights to the collateral and any recoveries in the case of a default.

Why It Matters: Fixtures vs. Personal Property

PMSIs will hold up if the collateral is regarded as personal property under the UCC. This may not be the case if they are regarded as "fixtures."

Fixtures represent something of an intermediate category between real property and personal property. Section 9-102 of the UCC defines fixtures as "goods that have become so related to particular real property that an interest in them arises under real property law" [5]. The category of fixtures can include installations such as a central air unit or a solar system.

The last part of the definition—about an interest arising in the fixture under real property law—has implications for solar financiers. Say a particular state makes the determination that solar systems are indeed fixtures [6]. Now say that a homeowner in that state installs a solar system on his/her roof and then a few years later defaults on his/her home mortgage loan. If the mortgage holder forecloses on that home as a result, then it may be able to claim rights to the system as per the provisions of state real estate law. This could, in effect, prevent the solar financier from repossessing its collateral or obtaining first claim on any recoveries from that collateral.

Obviously, this represents a business risk for the residential solar industry, and many finance/installation companies have consequently taken the position that solar assets are personal property, not fixtures [7]. Their contracts (leases, PPAs, and loan documents) contain language specifying them as such, although this language does not bind the real estate mortgagee unless he/she also signs that same contract, or signs a disclaimer of any interest in the solar system.

But even if homeowners and the solar industry intend that rooftop PV installations are personal property, the ultimate deciders on this issue are the state courts and arbiters who would be called upon to resolve any competing claims of the solar financier and the mortgage lender. Currently, there are no legal precedents in any state related to solar PV assets [8], so the legal outcomes are uncertain.

What Can Be Done?

There is an opportunity here. Instead of waiting for a legal dispute between a mortgage holder and a solar financier to go to court, the solar and mortgage banking industries could proactively seek an open dialogue to help each other mutually benefit from recognition of the solar asset class. For example, the two industries could mutually adopt some standard form of recognition that would allow the solar financiers to reach an agreement with new homeowners in previously foreclosed properties within, say, 90 days of the new owners buying the property (whether subject to the existing mortgage or a new one). This would sidestep any legal confrontations in the case of a foreclosure, and it would give solar financiers the opportunity to try and recover some cash flow on their collateral. If the solar industry could start such a dialogue with Fannie Mae and Freddie Mac, it stands to resolve potential conflicts with a large portion of the U.S. mortgage market, not to mention open the door for other mortgage banks to follow suit.

The mortgage industry could be in a position to benefit as well. Solar systems owned by the homeowner (i.e., loan-financed or purchased outright) have been shown to increase the value of the homes on which they're installed [9, 10, 11]. Moreover, recent guidelines from HUD indicate that solar systems can be financed with mortgages (allowing for a mortgage increase of up to 20% in excess of the maximum insurable limit) [12]. This which would increase principal amounts and therefore revenue potential for lenders. Lastly, homeowners that go solar in markets with a relatively high cost of electricity and access to net metering may enjoy positive cash flow even after taking out debt to finance their system. That is, it may cost a homeowner less, on a monthly basis, to service his/her solar loan than it would to pay the utility for all his/her electricity. This stands in contrast to some other types of consumer debt (such as credit cards or auto loans), where savings are not often part of the decision to assume an obligation.

As the cost of residential solar energy declines and as more markets open up, it will become ever more critical for the solar and mortgage industries to work together to avoid costly legal encounters and patchwork solutions.

References and Notes:

[1] Solar Energy Industries Association & Greentech Media Research. (2015). U.S. Solar Market Insight 2014 Year in Review.

[2] Solar Energy Industries Association & Greentech Media Research. (2014). U.S. Solar Market Insight 2013 Year in Review.

[3] The Solar Foundation. (2015). National Jobs Census 2014. Available at: http://www.thesolarfoundation.org/national-solar-jobs-census-2014/

[4] Filing a UCC-1 is not the only way to perfect a security interest, though it is the most common. For example, sometimes a security interest can be perfected "automatically," i.e. without any filings or actions on the part of the creditor.

[5] Cornell University Law School. "Uniform Commercial Code: § 9-102. Definitions and Index of Definitions."  Available at: https://www.law.cornell.edu/ucc/9/9-102

[6] Section 9-301 (3) of the UCC states that the "local law of that jurisdiction" (i.e. state realty law) governs perfection of a security interest by filing a fixture filing. In other words, the determination of whether or not a solar system is a fixture or personal property will be made on a state-by-state basis.

[7] A UCC-1 Financing Statement can be used for a "fixture filing." However, it is important to note that a fixture filing in the real property records does not, in and of itself, necessarily characterize the items affixed to the home as fixtures

[8] However, there has been case law where solar water heaters were held to be fixtures under the UCC. See re Arlett, 22 B.R. 732, 732-35 (Bankr. E.D. Cal. 1982), and Energy Control Services v. Arizona, 658 P.2d 820 (1982).

[9] Hoen, B.; Wiser, R.; Thayer, M.; Cappers, P. (2012). Residential Photovoltaic Energy Systems in California: The Effect on Home Sales Prices. Berkeley, CA: Lawrence Berkeley National Laboratory. Available at: https://emp.lbl.gov/sites/all/files/lbnl-5901e_0.pdf

[10] Hoen, B.; Adomatis, S.; Jackson, T.; Zivin-Graff, J.; Thayer, M.; Klise, G.; Wiser, R. (2015). Selling into the Sun: Price Premium Analysis of a Multi-State Dataset of Solar Homes. Berkeley, CA: Lawrence Berkeley National Laboratory. Available at: https://emp.lbl.gov/sites/all/files/selling-into-the-sun-jan12.pdf

[11] Desmarais, L. (2013). The Impact of Photovoltaic Systems on Market Value and Marketability: A Case Study of 30 Single‐Family Homes in the North and Northwest Denver Metro Area. Colorado Energy Office. Available at: http://www.colorado.gov/cs/Satellite%3Fblobcol%3Durldata%26blobheadername1%3DContent-Disposition%26blobheadername2%3DContent-Type%26blobheadervalue1%3Dinline%3B%2Bfilename%253D%2522PV_Case%2BStudies.pdf%2522%26blobheadervalue2%3Dapplication/pdf%26blobkey%3Did%26blobtable%3DMungoBlobs%26blobwhere%3D1251900073057%26ssbinary%3Dtrue

[12] The U.S. Department of Housing and Urban Development. (2015). FHA Single Family Housing Policy Handbook. II.A.2.a.v.(C), pg. 114. Available at: http://portal.hud.gov/hudportal/documents/huddoc?id=40001HSGH.pdf