Navigating Troubled Waters: Updates to water insolvency legislation amid growing concerns about the sector

New legislation hit the statue books on Wednesday bringing updates to the legislation governing special administrations for regulated water companies in England and Wales. The changes are timely (some may even consider them overdue) given the current market instability, and provide flexible options should the regime have to be used.

The state of the water industry has attracted significant media attention in recent months. Thames Water, which supplies water to about 25% of the population in England, is reported to have debts of GBP18 billion and may require government intervention. Other large water industry companies in England and Wales are also facing challenges, including (but not limited to):

• high debt burdens;
• long term underinvestment;
• rising costs; and
• penalties for failing to monitor storm overflows.

The new legislation provides more options and flexibility for the restructuring of water companies, not least by facilitating the use of innovative restructuring plans in the sector.

What is a special administration regime?

Special administration regimes modify the normal administration process for businesses where there is a wider public interest. Examples of established regimes include for railway companies, energy companies and certain financial institutions. A recent high-profile example was the special administration of Bulb Energy, one of the UK’s biggest energy suppliers, in 2021. The sale of the business to Octopus Energy was completed in December 2022. Ensuring continuity of service to the public is fundamental to special administration regimes.

The water industry special administration regime (WISAR)

WISAR applies to:

• any water company holding an appointment as a relevant undertaker; or
• any water company which is a qualifying licensed water supplier, qualifying water supply licensee or a qualifying sewerage licensee when the company either becomes insolvent (insolvency WISAR) or fails to carry out its statutory functions or licenced activities making it inappropriate for the company to hold its appointment or licence (performance WISAR).

Either the Secretary of State or the regulator, Ofwat (with the Secretary of State’s consent) may apply to the High Court for a special administration order. Following this, a special administrator is appointed who manages the affairs, business and property of the company.

Previously, the WISAR has provided for the continuation of water and sewage services pending a transfer of the business as a going concern to another water company.

What is the new legislation?

There are four relevant pieces of new legislation which modify the current WISAR:

1. The Flood and Water Management Act 2010 (Commencement No. 10) Order 2024, which became effective on 12 January 2024.
2. The Water Industry (Special Administration) Regulations 2024, which were made on 22 February 2024. These Regulations modify the provisions of Schedule B1 to the Insolvency Act 1986 in relation to a water company that enters administration.
3. The Water Industry Act 1991 (Amendment) Order 2024, which was made on 22 February 2024. This amends Schedule 2 to the Water Industry Act 1991 to include provisions relating to transfers by hive-down.
4. The Water Industry (Special Administration) Rules 2024, which were made on 26 February 2024 and come into force on 19 March 2024. The rules governing WISARs have been updated based on the Insolvency (England and Wales) Rules 2016.

What changes are being made?

1. Transfer by hive-down

A new option has been introduced to permit transfers of the business by hive-down. Hive-downs are commonly used in restructurings as they allow an administrator to ringfence value, making the company more attractive to potential buyers. The Water Industry Act 1991 (Amendment) Order 2024 provides that, in a WISAR, the transfer of the water company as a going concern can be effected by transferring all or part of the company’s undertaking to a wholly-owned subsidiary, followed by a transfer of the shares in that subsidiary to another company.

Under the previous regime, only a direct sale of assets was possible which is more complex and expensive. It is hoped that the changes to the legislation will allow the special administrator to benefit from the corporate tax savings of a hive-down and achieve the best value for money on a transfer at the end of the special administration. In addition, the special administrator can sell an entity “clean”, leaving behind existing liabilities that may be unattractive to a potential purchaser.

2. Rescue

The Flood and Water Management Act (Commencement No. 10) Order 2024 expands the objectives of an insolvency WISAR to include rescue.

The changes allow a water company to restructure its debts and exit special administration as a going concern. Under the old regime, a company could only be transferred to a new owner, following which the water company would be liquidated or dissolved. This change is intended to assist water companies that are struggling to manage high debt burdens, but are otherwise viable, to continue to operate.

It is worth noting that this only applies to insolvency WISAR; if the company enters a performance WISAR, the only exit route available is via a transfer.

3. Modifications to the legislation

There are additional changes to the existing legislative infrastructure, with the aims of:

• modernising the legislation to bring it up to date with modern insolvency practices and the special administration legislation that applies to other industries (e.g. energy/banks);
• ensuring that the Secretary of State controls the appointment of a water company special administrator and has the right to make certain decisions and receive key information in order to protect the interests of customers; and
• modifying the hierarchy of purposes and the objective of the administration to ensure the continuation of essential water and sewage services pending the rescue or transfer of the company (which can be contrasted to a normal administration where the administrator pursues an objective in the interests of the creditors as a whole).

Key changes to the legislation which reflect those aims include the following:

• Rescue Purpose: The special administrator must explain in proposals why the rescue of the company as a going concern is not likely to be possible, or why a transfer is likely to secure more effective performance of the functions or activities of the company¹, therefore introducing “rescue” as an additional purpose in the legislation.

• Debt Restructuring: Parts 26 and 26A of the Companies Act 2006 will be modified, so that schemes of arrangement and restructuring plans can be used by water industry companies as tools for restructuring their debt.²

• Protection of government funding and taxpayer money: Any grants, loans and repayments in respect of guarantees provided by the Government rank ahead of the ordinary expenses of the special administration.³

• Special administrator’s conduct: The grounds to challenge the conduct of a special administrator require a higher bar to be met than in a normal administration and must be based on a claim that the special administrator is “conducting the special administration in a way that is preventing its purposes from being achieved as quickly and efficiently as reasonably practicable”.⁴ Only the Secretary of State or Ofwat can apply to the Court for the replacement of the special administrator.⁵

• Exit: An exit from the special administration via a creditors’ voluntary liquidation (CVL) or dissolution will require the consent of the Secretary of State or Ofwat.⁶

Given the continuing uncertainty surrounding the future of many of the largest water companies in England and Wales, the Government is clearly keen to ensure the special administration process is fit for purpose in the event it is required to be used this year. The new tools provided for in these changes provide options for earlier intervention to restructure the finances of water companies and deal with fundamental debt challenges, as well as to implement more targeted transfers.

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