Investment Company Act of 1940 — Sections 3(c)(5)(A) and (B)
Hannon Armstrong Sustainable Infrastructure Capital, Inc.
September 29, 2016
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Your letter dated September 13, 2016 requests our assurance that the staff of the Division of Investment Management (the “Staff”) will not recommend that the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”) take enforcement action against certain majority-owned subsidiaries (each, an “HA Subsidiary”) of Hannon Armstrong Sustainable Infrastructure Capital, Inc. (“Hannon Armstrong”) under Section 7 of the Investment Company Act of 1940, as amended (the “1940 Act”), if each of the HA Subsidiaries, in reliance on Sections 3(c)(5)(A) and/or (B) of the 1940 Act, operates in the manner described in your letter and summarized below without registering with the Commission as an investment company under the 1940 Act.
You state the following:
Hannon Armstrong is a publicly-traded company engaged in the business of providing debt and equity financing to participants in the energy efficiency and renewable energy sector. The HA Subsidiaries are primarily engaged in making loans and acquiring notes evidencing loans (“Notes”) to project companies (“ProjectCos”) or managing members of ProjectCos (“Managing Members”) which are owned by renewable energy companies, including solar energy and wind energy companies.
A renewable energy company or an affiliated ProjectCo directly enters into power purchase agreements (“PPAs”) and/or lease arrangements with residential, commercial, or utility customers. An HA Subsidiary makes loans to and/or acquires Notes from a ProjectCo or the Managing Member of a ProjectCo. The Notes held by an HA Subsidiary are repaid solely through payments received on the PPAs or leases by the ProjectCo, except in limited cases described below, with payments dependent on customer energy usage (as described below).
The purpose of either a lease or PPA is to provide for the purchase of energy and Related Services from the renewable energy company. Renewable energy companies typically choose which type of agreement to use based on regulatory considerations and/or customer preferences. In general, from the perspective of a renewable energy company, leases and PPAs are economically equivalent and largely can be used interchangeably.
Under a lease, a solar energy company, for example, leases equipment such as solar panels to a customer who pays a fixed monthly amount in exchange for a guaranteed minimum amount of electrical energy over the term of the lease. Solar power customers do not enter into the leases for the purpose of reselling energy or purchasing the solar panels. The purpose of a lease is to provide energy for the customer’s own use. Leases do, however, frequently include a purchase option at the end of the lease term equal to fair market value of the leased equipment. Under a PPA, a renewable energy company builds or installs renewable energy infrastructure in order to provide energy to its customers. For example, if the customer is an end user, a solar energy company installs infrastructure such as solar panels on the customer’s home or commercial building. The solar energy company guarantees that a minimum amount of energy will be produced by the solar panels and is obligated to maintain and repair the solar panels, and the customer pays for the energy produced by the panels on an ongoing basis. Although the PPAs provide for variable payments based on the amount of energy delivered by a project, rather than fixed monthly payments, they are otherwise economically indistinguishable from the leases. As under the leases, the goal is to provide energy and Related Services in exchange for customer payments.
The HA Subsidiaries are each engaged in making loans evidenced by Notes to ProjectCos or their Managing Members and/or purchasing such Notes. In return for the purchase price of the Notes, a ProjectCo (or its Managing Member) makes payments to the HA Subsidiary from cash flows based on customer payments on specific leases and/or PPAs. This mechanism allows renewable energy companies and their ProjectCos or Managing Members to monetize future cash flows from leases and/or PPAs in order to fund their current activities.
The Notes held by an HA Subsidiary are repaid solely from payments that a ProjectCo (or renewable energy company, as the case may be) receives on a specified set of leases or PPAs (except in the cases of default). Because returns on the Notes depend on customer payments on the leases and PPAs, in deciding whether to acquire the Notes, an HA Subsidiary considers factors such as the amount of energy anticipated to be delivered under a PPA or lease, the age of the lease or PPA, the status of construction and the quality of the applicable infrastructure or equipment, the probability of default by a customer, and other factors. These factors help the HA Subsidiary determine the potential future cash flows that may be generated to support payments on the Note.
You represent that each HA Subsidiary currently holds at least 80 percent of the value of its total assets in the Notes and other notes that you believe should qualify as Section 3(c)(5)(A) and/or (B) qualifying assets, and that at least 80 percent of the net income after taxes received by each HA Subsidiary for the past four fiscal quarters combined was derived from the Notes and other notes that qualify as Section 3(c)(5)(A) and/or (B) qualifying assets. You represent that none of the HA Subsidiaries has issued, and none now issues or proposes to issue, redeemable securities, face-amount certificates of the installment type, or periodic payment plan certificates.
A. Section 3(c)(5)(A) and (B)
As relevant here, Section 3(c)(5) of the 1940 Act excludes from the definition of “investment company”:
Any person who is not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and who is primarily engaged in one or more of the following businesses: (A) Purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services; (B) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services . . .
You contend that each HA Subsidiary meets the requirements of Section 3(c)(5) because it is primarily engaged in the non-investment company business of: (A) purchasing or otherwise acquiring notes representing part or all of the sales price of merchandise and/or services; and/or (B) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise and/or services.
B. The “Primarily Engaged” Requirement
To rely on Section 3(c)(5), an issuer must be “primarily engaged” in one or more qualifying businesses. We have provided no-action assurance where, among other things, an issuer has established that a substantial majority of its assets are comprised of qualifying assets. You represent that each HA Subsidiary currently holds at least 80 percent of the value of its total assets in the Notes and other notes that qualify as assets under Section 3(c)(5)(A) and/or (B), because, as described below, you believe that the energy and Related Services provided by a renewable energy company are “merchandise and services” for purposes of Section 3(c)(5)(A) and (B).
C. Section 3(c)(5)(A)
To rely on Section 3(c)(5)(A), an issuer must purchase or otherwise acquire, among other instruments, notes. You represent that the HA Subsidiaries acquire the Notes either by originating associated loans or purchasing the Notes. In addition, the exclusion from the definition of investment company provided by Section 3(c)(5)(A) is available only to those issuers that are primarily engaged in the business of acquiring qualifying obligations “representing part or all of the sales price of merchandise . . . and services . . . .” In this regard, we have stated that a note or other obligation must relate to the sale of specific merchandise, insurance or services to be a qualifying obligation under Section 3(c)(5)(A). You believe that because the PPAs and leases provide for customers to pay amounts tied to the receipt of energy and Related Services, and are otherwise primarily structured to facilitate the provision of energy and Related Services, both the PPAs and leases are best understood as contracts for the purchase and sale of energy and services (and not leases of equipment). You further believe that because the Notes held by an HA Subsidiary entitle it to payments based on the payments for energy and Related Services under the PPAs and leases, the Notes represent part or all of the sales price of merchandise and services for purposes of Section 3(c)(5)(A).
With respect to whether energy should qualify as “merchandise” and Related Services should qualify as “services” under Section 3(c)(5)(A), you note that we have previously considered forms of energy to be “merchandise or services” for purposes of Section 3(c)(5)(B) and you believe that it is reasonable to take the same position for purposes of Section 3(c)(5)(A). In particular, you state that under the leases and the PPAs, the Related Services involve generating, transmitting, and distributing energy, and therefore should be treated as “services” for purposes of Section 3(c)(5)(A).
D. Section 3(c)(5)(B)
To rely on Section 3(c)(5)(B), an issuer must “mak[e] loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise . . . and services . . . .” You represent that certain HA Subsidiaries acquire the Notes by making loans to ProjectCos and/or their Managing Members, and that each HA Subsidiary that originates loans satisfies the requirement of Section 3(c)(5)(B) that it make loans. You also believe that because the PPAs and leases are best understood as contracts for the purchase and sale of energy and services, they should qualify as merchandise and services under Section 3(c)(5)(B). You contend that ProjectCos and their Managing Members produce energy and use the PPAs and leases to sell energy and Related Services to utility companies (who sell the energy to end users), and are therefore “manufacturers, wholesalers and retailers” for purposes of Section 3(c)(5)(B). You further argue that the loans relate to “specified merchandise [and] services” because payments flow to the HA Subsidiaries from payments made to each ProjectCo by customers for the purchase of energy and Related Services.
Based on the facts and representations provided in your letter, we would not recommend that the Commission take enforcement action against an HA Subsidiary under Section 7 of the 1940 Act if such HA Subsidiary, in reliance on Section 3(c)(5)(A) and/or (B) of the 1940 Act, operates in the manner described in your letter without registering with the Commission as an investment company under the 1940 Act.
This response expresses our position on enforcement action only, and does not express any legal conclusions on the issues presented. Because this position is based on the facts and representations in your letter, you should note that any different facts or circumstances may require a different conclusion.
Kyle R. Ahlgren
 Renewable energy companies are companies that develop, construct, and maintain renewable power systems and infrastructure as a source of generating energy. Renewable energy companies may provide energy and related services (“Related Services”) directly to end users, such as residences and businesses, or to power companies, such as public utilities, which deliver energy to their own end users. Under the leases, a renewable energy company is responsible for Related Services such as designing, permitting, constructing, installing, testing and activating the equipment covered by the lease; connecting the equipment to and providing ongoing access to the electrical grid; testing operations and training the customer on how to use the equipment; and maintaining the equipment. Under the PPAs, the Related Services involve designing and constructing the infrastructure; performing all required studies (such as environmental impact studies); obtaining any necessary regulatory approvals, certifications and verifications; and coordinating with independent service operators or similar entities that operate the applicable energy grid(s) associated with delivering the energy produced under the PPA.
 In most cases, at the end of each year, the solar energy company refunds the customer to compensate for energy production below the guarantee, but the customer does not have to make an additional payment for any amounts exceeding the guarantee. The solar energy company credits the customer for any excess energy produced by the panels, and uses those credits to cover any future shortfalls. Thus, although payments on the lease are flat each month, the size of the aggregate payments made by the customer is ultimately variable and dependent on energy usage and energy production by the solar panels.
 Certain HA Subsidiaries also may acquire Notes from wind energy companies that are repaid through the proceeds of PPAs associated with wind energy generation projects. These PPAs function in the same fashion as the solar PPAs described above.
 You represent that the only instances in which payments on the Notes are not made solely from customer payments involve cases of mandatory prepayments or default. You state that both types of provisions are common protections in renewable energy financing agreements, and without such protections an HA Subsidiary would have difficulty financing its transactions. You further state that mandatory prepayments are primarily triggered by unforeseen and relatively uncommon events such as casualty insurance payments or condemnation recoveries, and that in default, an HA Subsidiary is typically provided the right to exercise voting and other ownership rights over a broad range of assets of the applicable renewable energy company. Finally, you state that such assets may include the entity’s rights under various agreements, insurance, equity interests and other securities, hard assets, and others.
 You state that you are not requesting the Staff’s views as to whether the notes held by the HA Subsidiaries – other than the Notes – are qualifying assets for purposes of Section 3(c)(5)(A) or Section 3(c)(5)(B).
 See Royalty Pharma, SEC Staff No-Action Letter (Aug. 13, 2010) (no-action position under Section 3(c)(5)(A) where 79% of the issuer’s assets were comprised of royalty interests obligating others to pay royalties representing part of the sales price of specific biopharmaceutical products); New England Education Loan Marketing Corp., SEC Staff No-Action Letter (May 22, 1998) (“Nellie Mae”) (no-action position under Section 3(c)(5)(A) and (B) where the issuer’s primary (and, effectively, sole) business was originating or purchasing notes representing student loans); Econo Lodges of America, Inc., SEC Staff No-Action Letter (Dec. 22, 1989) (no-action position under Section 3(c)(5)(A) where at least 55% of the issuer’s assets consisted of notes representing franchise fees owed by franchisees for an integrated package of services provided by its parent company) (“Econo Lodges”). The Staff has also provided no-action assurance under Section 3(c)(5) where, among other things, a substantial majority of an issuer’s income would be derived from qualifying receivables. See Econo Lodges. As noted above, you represent that at least 80 percent of the net income after taxes received by each HA Subsidiary for the past four fiscal quarters combined was derived from the Notes and other notes that qualify as Section 3(c)(5)(A) and/or (B) qualifying assets.
 Nellie Mae at 5.
 You note that the leases typically provide an option to purchase the equipment at fair market value upon termination. You note that the Staff in B.C. Ziegler and Company, SEC Staff No-Action Letter (Sept. 11, 1991) suggested that leases with the option to purchase are qualifying assets for purposes of Section 3(c)(5)(A) only if a portion of each payment on the lease represents part of the purchase price of the leased equipment. You argue, however, that the obligations under the leases here represent all or part of the sales price of the energy and Related Services delivered pursuant to the leases.
 You cite to National Rural Utilities Cooperative Finance Corporation, SEC Staff No-Action Letter (Nov. 15, 1974) (providing no-action assurance under Section 3(c)(5)(B) to a cooperative making loans to member rural electric systems that delivered electricity to local distribution systems, which in turn sold the electricity to consumers) and Colorado-Ute Financial Services Corporation, SEC Staff No-Action Letter (May 5, 1986) (providing no-action assurance under Section 3(c)(5)(B) to a company providing loans to an electricity cooperative and its member cooperatives, where the loans funded the purchase of electric generating, transmission and distribution facilities, equipment and machinery).
 You note that these Related Services include designing and constructing the equipment and/or infrastructure, testing and activating the equipment, performing all required studies (such as environmental impact studies), and training the customer on how to use the equipment, as applicable depending on whether the Related Service is covered by the lease or the PPA.
Incoming LetterThe Incoming Letter is in Acrobat format.