The Inflation Reduction Act of 2022 created the ability to transfer production tax credits (“PTC”) to an “eligible taxpayer” pursuant to Section 6418 of the Internal Revenue Code (“IRC”). However, exactly when an eligible taxpayer acquires a PTC is often not clear. Such uncertainty creates fertile ground for disputes, especially in bankruptcy.

PTCs arise under federal tax law, so it may be presumed that an eligible taxpayer does not acquire a PTC until the close of the applicable tax year (and then only when a return is filed). Moreover, an eligible taxpayer does not have the right to transfer a PTC until the following conditions are met: (i) registration of the PTC with the Internal Revenue Service (“IRS”); (ii) execution of a binding purchase agreement; (iii) generation of the PTC; (iv) filing of information pertaining to the PTC on a timely basis; and (v) filing of a transfer election statement with the eligible taxpayer’s annual return, which identifies the transferee taxpayer. See IRC, Section 6418.

Since PTCs are generated on a rolling basis as energy is produced, PTCs may be acquired from an eligible taxpayer for a single year, for multiple years into the future, or even for the life of a project. Such agreements are executory in nature (i.e., a contract for which there remains something to be done on both sides).

Furthermore, PTCs are not transferred contemporaneously with the execution of an agreement for their purchase, such transactions come with typical transactional risks that require extensive due diligence and careful purchase agreement drafting. Due to their executory nature, agreements to purchase PTCs have unique risks in the context of a bankruptcy filing by an eligible taxpayer. Specifically, the bankruptcy code affords debtors the right to reject executory contracts (like PTC purchase agreements), provided rejection is in the best interest of the bankruptcy estate. Thus, debtors/eligible taxpayers might reject purchase agreements and instead offer the subject PTCs to third parties willing to pay higher prices in order to capture greater value for the bankruptcy estate. Due to the existence of such bankruptcy-related risks, transferee taxpayers should consider incorporating provisions into purchase agreements to protect their rights in the event of bankruptcy. One option is to draft PTC purchase agreements in such a manner as to eliminate all future performance by transferee taxpayers, which would require significantly different structuring than current industry standards. With no future performance obligations, the purchase agreements would be non-executory and therefore not subject to rejection in bankruptcy.

Alternatively, parties have attempted to draft purchase agreements as forward contracts and/or master netting agreements to obtain the safe harbor protections afforded such contracts by the bankruptcy code. However, it is currently uncertain whether such attempts to classify PTC purchase agreements as forward and/or master netting agreements will prove successful.

At a minimum, PTC purchase agreements should include extensive representations and warranties, indemnity protections, and bankruptcy-related provisions. Given the extremely limited guidance offered by the courts, it is unclear whether such bankruptcy-related provisions will prove successful in the event of litigation. Nevertheless, well-drafted bankruptcy-related protections can bolster a PTC buyer’s position (and rights to the PTCs) in the event of bankruptcy.