On June 23, 2014, Covington & Burling (C&B), on behalf of affiliates of SolarCity Corporation (“SolarCity”) filed a motion in the Court of Federal Claims to compel Treasury to produce documents related to the setting of benchmark values for determining appropriate Cash Grant 1 awards. The motion is available here. A prior post discussing this litigation and providing background is available here. The essential substantive issue in the case is that SolarCity’s affiliates have brought an action claiming that Treasury miscalculated their eligible tax basis and accordingly made Cash Grant awards that were less than those to which they were entitled.
The discovery motion is quite persuasive. It seems likely that the court will compel Treasury to comply with all (or at least most) of the discovery demands from SolarCity’s affiliates.
The Department of Justice (DOJ), on behalf of Treasury, asserts that only documents directly related to the Cash Grant applications in question should have to be produced; therefore, documents relating to the Cash Grant program generally should not have to be produced.
DOJ’s rationale is as follows: the Cash Grant program is intended to “mimic” the investment tax credit. When Internal Revenue Service (IRS) determinations are litigated, the IRS’s factual findings are reviewed by the court de novo. Because a de novo review requires the court to reach its own factual conclusions, the factual conclusions (and the process for developing such conclusions) of Treasury with respect to the Cash Grant program are not relevant.
In response, C&B cites cases that hold that, when litigating with the government a matter that will be subject to de novo review, the government can be compelled to produce information if the plaintiff can demonstrate that the information would be relevant to its claims. When the primary issue in the case is whether an arm’s-length price was paid for the solar systems, it does not appear tenable for DOJ to assert that documents related to Treasury’s determination of benchmark arm’s-length prices are not relevant to SolarCity’s claim.
The motion documents how Treasury evolved from a benchmark price for residential solar in California of $7/watt in June 2012 to $6/watt in December 2012. However, the change was not announced publicly; SolarCity was informed in a private email. Shortly after that informal change, Treasury stopped communicating its benchmarks even to large applicants like SolarCity and admitted that “continuing to publish benchmarks is not useful.” Testimony of Ellen Neubauer, the Treasury lawyer who administers the Cash Grant program, is recounted as providing that Treasury replaced benchmarks “with threshold amounts that served the same essential purpose.”
Here are interesting excerpts from the motion:
- Of the 4,024 applications at issue in this litigation, 4,144 of them were for residential solar energy properties in California or Arizona that were placed in service after October 1, 2012. Each of those applications claimed a cost basis higher than the values identified in Ms. Neuabuer’s December 5, 2012, email, and, for each, Treasury reduced the cost basis amount for purposes of a Cash Grant award to an amount equal to the amounts in that email. Thus, the revised benchmark amounts clearly serve as de facto ceilings on the amount Treasury paid on nearly 99 percent of Plaintiff’s applications at issue. They are therefore obvious, substantial relevance to Treasury’s determination of the cash grant awards, and discovery regarding them is highly relevant. (p. 16)
In discovery, Plaintiffs have requested the following documents and information that specifically relate to those issues:
- Documents relating to Treasury’s calculation and use of “Benchmarks” in the valuation of Section 1603 applications, and the identification of all information used to update those amounts. Applications that claimed a cost basis higher than Treasury’s “Benchmark” amounts were routinely subjected to significantly delayed, and generally reduced, Cash Grant payments. The information requested here is relevant for at least four reasons:
- The Benchmarks influenced Treasury’s payment determinations;
- Treasury’s Benchmarks were artificial ceilings that compelled Section 1603 applicants to claim cost bases that were lower than the Benchmark amounts, regardless of the actual value of their subject properties, just to get paid, which, in turn, skewed market data against which future applications would be compared;
- Plaintiffs are entitled to obtain evidence to show that Treasury’s own original June 2011 Benchmarks better reflected the value of the properties than the lower amounts that Treasury retroactively adopted in December 2012; and
- Plaintiffs are entitled to know what methodologies and evidence Treasury considered and deemed sufficiently reliable to use in developing and revising the Benchmarks in the first place, and to impeach Treasury should it try to disavow those methodologies and that evidence in litigating this case. (p. 3)
- Documents relating to Treasury’s application of the Cost, Market and Income approaches to valuation for purposes of the Section 1603 Program. Treasury purported to apply these valuation approaches in reviewing and adjusting Plaintiffs’ applications. This evidence is relevant to determine whether:
- Treasury undervalued Plaintiffs’ applications because it misapplied these methodologies; and
- In its internal application of these methodologies, Treasury accepted concepts, assumptions or the accuracy of data that supports Plaintiffs’ contentions as to value. (p. 3)
- Documents relating to the valuation of solar energy properties for purposes of the Investment Tax Credit (ITC). These documents are necessary because the Section 1603 program was intended by Congress to “mimic” the ITC; they will demonstrate that Treasury’s evaluation of the applications at issue was inconsistent with ITC valuation principles, further demonstrating the errors in Treasury’s determination of Plaintiffs’ applications. (p. 3)
- Specific information related to third-party Section 1603 applications for which Treasury concluded that the cost basis for the property was less than that identified on the application. Treasury received and paid tens of thousands of applications for Section 1603 grants. By its own admission, Treasury compared Plaintiffs’ applications at issue to “thousands” of other Section 1603 applications. Thus, the requested information is relevant because:
- Plaintiffs contend that Treasury improperly reduced the claimed cost basis on other Section 1603 applications, which skewed the set of market data against which Plaintiffs’ applications were compared, and which data Treasury may seek to use in its defense in this case. (p. 3-4)
- Defendant has spent the last five years evaluating Section 1603 applications, discussing valuation approaches with industry participants, reviewing and applying methods for valuing solar energy properties, assessing claimed cost bases for solar energy properties, applying valuation standards to tens of thousands of solar energy properties, and developing and publishing valuation benchmarks to direct the market. Nonetheless, Defendant’s position is that any examination of what it has said and done over those five years is off limits—even if it would corroborate Plaintiff’s arguments and evidence, and even if it would directly contradict the arguments and evidence that Defendant offers now. (p. 8)
- Income Approach. SolarCity finances the construction of solar energy systems by forming limited liability companies, such as the Plaintiffs here, with third-party tax equity investors. Those limited liability companies purchase or lease solar energy systems from SolarCity as an investment. Treasury has refused to accept the price that the limited liability company paid for the property as the cost basis. Moreover, from time to time, although not always, Treasury has taken the position that a specific third party investor’s rate of return on its contribution to a specific partnership establishes the appropriate discount rate for purposes of the Income Approach to valuation for that partnership’s solar energy properties. Treasury’s position violates generally accepted and industry-standard valuation methodologies, which recognize that a discount rate is properly calculated by weighting proportionally the cost of debt and equity used to finance a certain class of asset to calculate a weighted-average cost of capital. (p. 19)
- Defendant cannot simultaneously admit that its conduct is governed by the ITC standard and then refuse to produce any documents in its possession that speak to what that standard requires, and whether Treasury has, in fact, satisfied it. The information requested here is relevant and should be produced. (p. 22)
- Treasury’s “Evaluating Cost Basis” document explains that the “Market Approach” to valuation is “[b]ased on sales of comparable properties.” Also, Treasury has confirmed that it relied on “thousands” of Section 1603 applications submitted by other applicants in making its determination upon Plaintiffs’ applications at issue here. However, by improperly reducing the cost basis of comparable solar energy properties identified in other Section 1603 applications, as Plaintiffs allege Treasury did, the “thousands” of other applications that Treasury used as part of its evaluation of Plaintiffs’ applications here represented a distorted market where the valuations of comparable properties were too low. As a result, Treasury’s determination of the valuation of properties in Plaintiffs’ applications, to the extent based upon comparisons to those properties, was also improperly low. (p. 24)
- Moreover, Treasury has argued that it is allowed to disregard the purchase price of a solar energy property, and apply a lower cost basis, if Treasury concludes that the purchase is accompanied by “unusual circumstances.” Leaving aside the fact that Treasury misapplies this narrow legal principle, the data that Plaintiffs seek is relevant to show that Treasury simply invokes its “unusual circumstances” rule any time the claimed cost basis exceeds Treasury’s arbitrary Benchmarks. In addition, this data is relevant to show that the Benchmarks did, in fact, operate as de facto ceilings on grant amounts. (p. 24)
Finally, somewhat disturbing is the statement at the end of the motion:
Treasury routinely communicated directly with SolarCity and its outside tax counsel about the valuations of SolarCity’s solar energy properties and SolarCity-related 1603 applications.… These communications included representations by Treasury that it agreed that the particular valuation method, data or other supporting evidence was reliable, reasonable, or otherwise appropriate. (p. 26)
This communication seems to have provided SolarCity with an advantage over solar developers who were before Treasury less often. Did Treasury realize that its practices gave an edge to SolarCity with respect to evaluating the cost of solar projects and negotiating Cash Grant indemnity levels with investors? Why should one participant in the market have had this information, while smaller developers did not?
1 The Cash Grant is provided for in Section 1603 of division B of the American Recovery and Reinvestment Act, as amended. For wind and solar projects, the Cash Grant is 30 percent of “eligible basis.” Solar projects have until the end of 2016 to be “placed in service”; however, a preliminary Cash Grant application must have been filed before the end of 2012. Wind projects must have been placed in service before the end of 2012.