Legislature Clarifies Permissible Scope of Energy Improvement Projects

Section 1274a of the Revised School Code authorizes schools to undertake energy improvement projects and finance them through a variety of meth­ods. Under Public Act 23 of 2017, the Michigan Legislature previously amended Section 1274a to allow school energy improvement projects to include “operational improvements” in addition to traditional energy conservation measures, such as lighting retrofits or HVAC upgrades. Because that amendment did not define “operational improvements,” there had been some uncertainty about the permissible scope of ener­gy im­provement projects. The recently enacted Public Act 135 of 2018, effective May 10, 2018, provides clarification but also prompts additional questions.

“Operational improvements” now expressly include “installing equipment or providing services that result in decreased, eliminated, or avoided operating or maintenance costs.” Accordingly, a school en­ergy project may encompass non-energy conserva­tion related improvements, such as installing artificial turf in place of grass.

Also included within the meaning of “operational improvements” is “adding square footage to existing school buildings.” While providing flexibility for schools, this addition blurs the line between energy improvement projects and conventional school con­struction, which are subject to different legal requirements. For example, unlike conventional con­struction, energy improvement projects under Section 1274a permit a “design-build” project delivery method where the designer is also the contractor.

Section 1274a also allows financiers to claim a security interest in energy and operational improve­ments. With the newly added definition of “operational improvements,” it is unclear how a secu­rity interest in a project that adds square footage can be reconciled with general principles prohibiting a school from granting a security interest in its land and buildings (i.e., a mortgage). It is also unclear whether added square footage must be related to an energy or operational improvement.

Additionally, Section 1274a now allows an energy performance contract to include a financial guarantee in which a school would pay only the cost of improve­ments if operational savings are sufficient to cover those costs. Theoretically, that would benefit schools. Energy performance contractors, however, are unlikely to defer payment until a project’s operational costs are realized several years after the project’s completion. Moreover, a typical energy performance guarantee contract stipulates the amount of opera­tional savings. In other words, by signing the contract, the parties agree to operational savings in a stated dollar amount without any actual measurement. That practice could render the financial guarantee meaningless.

While the permissible scope of an energy improvement project has expanded, the recent amendments to Section 1274a have created some confusion. If your school is considering an energy im­provement project, we recommend contacting a Thrun Law Firm transactional attorney to assist you.