Water special administration regime – what are the key changes?

Like many other strategically important sectors, there has long been a bespoke insolvency regime for the water sector. New legislation has been brought into effect in January 2024 as a first step to bringing the special administration regime for water (the SAR) up to date with the general UK insolvency regime. 

The combination of underlying operational issues including pricing pressures, regulatory restrictions and litigation in the water sector, combined with high levels of debt both at operational and holding company level, has resulted in difficulties attracting much-needed new equity. Could the updated regime be tested in the near future?  We are certainly closer to this than we have ever been. 

Here is a short summary of the changes and what is still missing. 

Summary of the key changes

The package of new legislation:

• introduces a new framework to rescue a regulated operating company as a going concern. This applies only where the special administration is commenced on the grounds that the company is (or is likely to be unable) to pay its debts. This was not possible prior to these changes as the only purpose of a special administration was the transfer of regulated functions to a new provider;
• makes available modified versions of the restructuring ‘toolkit’ (e.g. Schemes, Restructuring Plans and CVAs) to the regulated operating companies that are subject to the SAR; 
• will apply a modified version of Schedule B1 of the Insolvency Act 1986 to water companies to cater for the special nature of a water company’s administration; and
• permits the ‘hive-down’ of the operating business and assets into a new entity, facilitating a sale of a going concern business to a new purchaser and potentially leaving unwanted assets and liabilities behind in the seller group. 

Changes already in force

The following changes came into force on 12^th January 2024:

• The new statutory purpose of a special administration: rescue of the regulated operating company as a going concern; 
• The ability for a special administrator to propose schemes, CVAs, Restructuring Plans for the purpose of rescuing the Company as a going concern (but see below, changes to those tools for the water sector are not yet in force); and 
• The ability to transfer assets and liabilities via hive-down.

Changes not yet in force

• A draft regulation has been published setting out modified versions of the restructuring ‘toolkit’ (e.g. Schemes, Restructuring Plans and CVAs) to restructure regulated water operating companies; and
• A modified form of Schedule B1 of the Insolvency Act 1986, which brings the SAR more closely in line with the modern general insolvency regime.

Neither of these changes are yet in force. The government has published drafts of the relevant secondary legislation which are currently subject to review by the Joint Committee on Statutory Instruments. Parliament will then vote on the secondary legislation. It is expected that this will take place shortly, although the precise date has not been confirmed.

The government also plans to introduce an amended version of the Insolvency Rules 2016 for the water sector, further bringing the SAR into line with the modern ordinary administration regime. A draft of the new rules is anticipated later this year, to be enacted late this or early next year.  

Background to the SAR 

• The SAR is a bespoke insolvency regime, designed to protect key public interests in the insolvency of a regulated operating company. 
• It is important to note that the SAR does not apply to holding companies, which are not regulated by Owfat.  However, clearly any impact of the SAR at the regulated company level will be felt on the holding companies within the structure.
• The provisions for the SAR were first introduced by the Water Industry Act 1991 but have never been tested in practice and some of them have only just been brought into force.  Under the SAR, only Ofwat or the Secretary of State may petition the court for an order to place a regulated operating company into special administration. Creditors do not have a right to apply for such an order; there is also no right for secured creditors to nominate the administrator (unlike in the “ordinary” administration regime).
• Unlike special administration regimes for other sectors, the SAR is not only accessible where there is an (imminent) insolvency: the Secretary of State may also intervene earlier if regulatory breaches have occurred. 
• Before the introduction of changes in January 2024, the only primary statutory purpose of a special administration was to provide for a transfer of the regulated functions of the operating company to another provider (and to carry on those functions pending a transfer). 
• Following the changes, the primary statutory purpose of a SAR is now to rescue the regulated operating company as a going concern (if the reason for the SAR is that the company is (or is likely to be) unable to pay its debts).  It is only where rescue as a going concern is not possible that the statutory purpose is to transfer the regulated functions of the operating company to another provider. 

What is the impact of the new changes?

The introduction of a rescue purpose and the introduction of a modified Schedule B1 Insolvency Act 1986 brings the water SAR into line with the “normal” administration regime but the insolvency rules that implement the changes are yet to be published. 

The changes allow the regulated water companies to de-lever through a scheme of arrangement, or a restructuring plan implemented under a special administration, which may be needed if further equity solutions are not forthcoming or achievable. 

Depending on the structures, separate solutions may need to be found in parallel for the holding company debt if the existing equity holding structure is to be sought to be retained. Clearly the mere possibility of using the new powerful tools at the Regulated entity level (even if not actually used) may impact stakeholder dynamics at holding company/shareholder level and the terms of any restructuring.

Finally, the introduction of a hive-down mechanism permits multiple assets to be packaged up and sold in one transfer while leaving unwanted assets/liabilities behind.  The risk is that holders of company debt face being marooned depending on the level at which the sale takes place and whether their liabilities transfer to the new provider and if not, what value is achieved in the transfers, potentially opening the door for valuation questions.