Pouring Oil on Troubled Waters? New UK Special Insolvency Regime Is Now on Tap

The UK water industry is rarely out of the headlines, whether for operational performance issues or reports of perpetual financial distress. It may therefore be more than a coincidence that the UK government has chosen now to introduce new rules for the special administration regime (SAR) that applies to water companies.

In common with other utilities and key public infrastructure, maintaining continuity of service in the event that a private-sector provider becomes insolvent is a public policy priority. If a provider has a monopoly, as water companies do in specific geographies of the UK, this priority becomes critical. SARs are used sparingly. The most recent high-profile example in practice was Bulb Energy in the fragmented UK electricity sector. Perhaps scarred by the cost to the public purse of that experience, the government has taken the opportunity to expand the options available to a special administrator appointed to a licenced water company.

Rescue as a Going Concern

The main new objective is to prioritise the rescue of the company (as opposed to the business) as a going concern. In common with most other SARs, the previous water regime allowed only for the transfer by the special administrator of the business and undertaking of the insolvent water company to a third-party purchaser, while maintaining continuity of supply pending the transfer. A special administrator can now restructure a water company’s financial liabilities “in situ” (by using a compromise tool such as a Part 26A restructuring plan, Part 26 scheme of arrangement, or company voluntary arrangement) or “hive down” key assets to a subsidiary to facilitate the sale of the subsidiary company to a third party (potentially in a more tax-efficient transaction structure).

The new statutory purpose applies only if the water company has entered into special administration on insolvency grounds (being an inability to pay debts). A water company may also enter into special administration on performance grounds if it fails to carry out its statutory functions or licenced activities in a way that is “serious enough to make it inappropriate for the company to continue to hold its appointment or licence”.Water Industry Act 1991, s.24(2). Whether on insolvency or performance grounds, only the Secretary of State or Ofwat (the industry regulator, with the Secretary of State’s consent) may petition the court for a special administration order.

Further Amendments to the SAR Regime

Alongside the changes to the statutory purpose, the government has updated the SAR to apply a modified Schedule B1 to the Insolvency Act 1986,The Water Industry (Special Administration) Regulations 2024 (which came into force on 14 March 2024). together with updated SAR rules based on the Insolvency (England and Wales) Rules 2016.The Water Industry (Special Administration) (England and Wales) Rules 2024 (which came into force on 19 March 2024). The modifications to the ordinary administration regime include the following:

• A special administrator’s conduct may be challenged only if the special administrator “is conducting the special administration in a way that is preventing its purposes from being achieved as quickly and efficiently as is reasonably practicable”.Regulation 25, amending paragraph 74 of Schedule B1 to the Insolvency Act 1986. This basis of challenge is narrower than in an ordinary administration; note also that only the Secretary of State or Ofwat may apply to the court to replace the special administrator.
• A special administrator may dispose of fixed charge property with the leave of the court but only if the net disposal proceeds and any shortfall up to the “appropriate value” are applied in discharge of the secured debt. (In an ordinary administration, the yardstick is the more tangible “market value”). “Appropriate value” is defined as “the best price that could be reasonably available on a sale which is consistent with the achievement of the purposes of the special administration”.Regulations 22 and 40, amending paragraph 71 of Schedule B1 to the Insolvency Act 1986. In practice, this makes it very difficult to challenge successfully the exercise of the special administrator’s discretion in selling fixed charge assets.
• Express priority is given to grants, loans, and repayments with respect to guarantees that the government provides ahead of the ordinary expenses of the special administration (including the special administrator’s remuneration).Regulation 35, amending paragraph 99 of Schedule B1 to the Insolvency Act 1986.

Fit for Purpose?

The SAR applies only to a water company either holding an appointment as a water or sewerage undertaker, or which is a qualifying licensed water supplier, water supply licensee, or a sewerage licensee. The SAR does not extend to other finance-raising vehicles within a water company’s wider group. The financing structures of these groups are typically complex, multi-layered, and in some cases contain a securitised ringfenced sub-group. Any “in situ” restructuring proposal delivered by a special administrator at the water company level would not be capable of addressing structurally subordinated debt (often by way of shareholder loans) higher in the group’s structure.

The additional flexibility granted to any appointed special administrator should be seen in the context of the wider debate about the financial and regulatory health of the UK’s water sector. It follows heightened parliamentary scrutiny by the House of Lords Industry and Regulators Committee report on its inquiry into the work of Ofwat, which recommended that Ofwat be more proactive in using its special administration powers.The affluent and the effluent: cleaning up failures in water and sewage regulation, House of Lords Industry and Regulators Committee Report, 22 March 2023. Government and Ofwat responsesGovernment response (June 2023); Ofwat response (22 May 2023). emphasised the high barriers to entry into special administration, which remains the enforcement tool of last resort. However, the rapid introduction of an update and streamlined SAR may only add to speculation that it may be used for the first time in practice.

See our prior related article: UK Water – A Perfect Storm.