Proposed changes to Water Industry Special Administration Process

What is special administration?

The special administration regime (SAR) is a process that enables an insolvent or failing water industry company, which provides vital public services, to be put into special administration. The SAR aims to protect the interests of customers and the environment when a water or sewerage company is in financial distress or at risk of insolvency with a requirement that the public service will be provided pending rescue or transfer to new owners. The SAR is seen as the ultimate enforcement tool to ensure consumers are protected from the impacts of financial distress and that water and wastewater services will continue to be provided.

Which legislation governs special administration in the water sector?

Special administration is currently governed by Part IV of the Water Industry Act 1991 (WIA 1991) and the Water Industry (Special Administration) Rules 2009 (SI 2009/2479).

Changes to the existing legislation are being proposed by The Water Industry Special Administration Regulations 2024 (the Regulations). The Regulations are a statutory instrument that aims to update the special administration regime for water industry companies in England and Wales.

The Regulations are made under powers introduced by the Flood and Water Management Act 2010, which introduced special administration-related changes to the Water Industry Act 1991 (WIA). The Regulations are required in order to implement those changes and to align the SAR with the most up-to-date insolvency and restructuring legislation. A commencement order will be made to commence paragraph 6 of Schedule 5 to the Flood and Water Management Act 2010 in order to apply Schedule B1 of the Insolvency Act 1986 to the SAR and replace Schedule 3 to the WIA. Schedule B1 of the Insolvency Act 1986 sets out the general framework for the administration of insolvent companies, while Schedule 3 to the WIA contains the current provisions for the SAR.

Conditions required for a Special Administration

The Secretary of State for Environment, Food and Rural Affairs (Defra) or the Welsh Ministers can apply to the High Court for a water or sewerage company to be put into special administration if they are satisfied that one or more of the following conditions are met:

1. the company is unable or likely to be unable to pay its debts;
   
2. the company has failed or is likely to fail to meet its statutory or licence obligations;
   
3. the company has asked to be put into special administration; or
   
4. it is expedient in the public interest to do so.

Appointment of a Special Administrator

The High Court can appoint a special administrator, who must be a qualified insolvency practitioner, to manage the affairs of the company. The special administrator has the same powers and duties as an administrator under the Insolvency Act 1986, but with some modifications and additional objectives.

Current objectives of the SAR

The main objective of the special administration is to ensure the continued provision of water and sewerage services to the company's customers and the discharge of its environmental obligations. Under the existing legislation the aim of the SAR is to assist secure a transfer of the company or its assets to another company that can carry on the business effectively. The special administrator must also achieve the best result for the company's creditors as a whole, unless this is inconsistent with the main objective.

Proposed amendments to the objectives of the water SAR

The main changes that the Regulations propose to the water SAR are as follows:

1. The Regulations introduce rescue provisions to expand the key objectives of the SAR to include rescue. This will allow otherwise viable water industry companies to enter a special administration, restructure their debts and then exit the SAR as a going concern. Without this, the special administrator can only transfer the regulated business to a new owner and the old water industry company would then exit to liquidation or dissolution. However, rescue provisions are only available for insolvency SARs, so if a water industry company enters a performance SAR, its only exit route is via a transfer scheme.
2. The Regulations enable the special administrator to hive-down the regulated business to a subsidiary to benefit from potential tax savings and to attract potential buyers. Hive-down is a common, commercial restructuring practice to ringfence value and separate the regulated business from the unregulated business or other liabilities.
3. The Regulations apply Parts 26 and 26A of the Companies Act 2006 to the SAR via specific modifications. These Parts introduce schemes of arrangement and restructuring plans, which are forms of debt restructuring measures that can support the rescue of a water industry company. A scheme of arrangement is a tool to enable complex debt arrangements to be restructured and to support the injection of new finance, while a restructuring plan is modelled on the scheme of arrangement procedure but with the addition of the ability to cram down across classes of creditors.

It is important to note that the rescue purposes set out above only apply in instances where the special administration appointment is based on the grounds of the company’s insolvency. Where the SAR is based on a failure to carry out its statutory functions these restructuring options are not available.

Who can appoint a Special Administrator?

The Regulations amend section 26 of the WIA to prevent Schedule B1 of the Insolvency Act 1986 from being used to appoint an out-of-court administrator in relation to a water industry company. This is to ensure that only the Secretary of State, the Welsh Ministers or the regulator, the Water Services Regulation Authority (Ofwat), can apply to the court for a special administration order, as they have the public interest in mind.
The Regulations also prohibit a winding up order being made against a water company and must instead make an order appointing a special administrator if the court is satisfied that it would have been appropriate to make the winding up order had the company not been a water company.

Statutory obligations on the Special Administrator post appointment

The special administrator must prepare and submit a report to the High Court within three months of the appointment, setting out the proposals for achieving the objectives of the special administration. The report must also be sent to Defra or the Welsh Ministers, the water regulator (Ofwat), the Environment Agency, the Drinking Water Inspectorate, the company's creditors and shareholders, and any other interested parties.
The report must include a statement of the company's financial position, the reasons for the special administration, the options for transferring the company or its assets, and the likely impact on the customers, the environment, and the creditors. The report must also invite representations from the recipients within a specified period.

The special administrator must implement the proposals in the report, unless the High Court orders otherwise or the proposals are revised or withdrawn. The special administrator must also consult with Defra or the Welsh Ministers, Ofwat, and the Environment Agency on any matters that may affect the objectives of the special administration or the interests of the customers or the environment. The special administrator must also comply with any directions or guidance issued by Defra or the Welsh Ministers, Ofwat, or the Environment Agency.

A change proposed by the Regulations is that the proposals must explain why the rescue of the company as a going concern is not likely to be possible as compared to the transfer of the company functions to a buyer.

Government funding

The Regulations make it clear that any funding provided by HM Treasury to the Special Administrators is to be treated as a priority expense of the Special Administration.

Exit from Special Administration

Under the existing legislation the special administration ends when the High Court makes an order for the transfer of the company or its assets to another company, or for the dissolution of the company, or for the termination of the special administration. The High Court can only make such an order if it is satisfied that the objectives of the special administration have been achieved or cannot be achieved, and that the order is consistent with the interests of the customers and the environment. The High Court can also make an order for the payment of the costs and expenses of the special administration, which have priority over the claims of the creditors and the shareholders.

The Regulations introduce wider options for exit from Special Administration including creditors voluntary liquidation and dissolution.

What this means for the Water Industry

The aim of the proposed changes to the SAR legislation outlined in the Water Industry (Special Administration) Regulations 2024 explanatory memorandum is to ensure that, should a water industry company go into special administration, a special administrator is able to administer a modern, efficient SAR.

The explanatory memorandum notes that the Government prepares for all eventualities to ensure the uninterrupted provision of vital public services. There is a high bar for implementing a SAR and it is a tool to be used when other options have been exhausted.

We consider that by broadening out the purpose of the SAR and providing the special administrator with a greater array of restructuring options compared with the existing legislative framework the proposed amendments will allow the company, its stakeholders and any special administrator more latitude to come up with effective restructuring solutions. When we have worked with water stakeholders in the past this has been one of the key impediments to being able to address the underlying balance sheet issues.

Therefore we believe this should enable the underlying business to continue to provide service to customers whilst addressing any of the balance sheet debt issues that have created the insolvency event required to trigger access to these amendments. Hopefully, the regime will never get tested but if it does it should lead to better outcomes if those involved in the restructure apply the new legislation in the spirit it appears is intended.