Restructuring and insolvency in the retail energy industry: Q&A with Nick Middleton and Andrew Eaton

This Q&A explores the current trends in restructuring and insolvency activity in the retail energy industry and considers the industry-specific issues and risks practitioners should be aware of

24 May 2022

Overview

1. Have you seen significant restructuring and insolvency (R&I) activity in the retail energy industry in the last 12 months?

The recent problems (and attrition) in the retail energy supply industry have been well publicised. There have been more than 20 energy supply company failures since September 2021 alone (see Ofgem: Recent supplier exits and take-over suppliers). Ofgem, which regulates the electricity and downstream gas sector in Great Britain, has frequently had to call upon its Supplier of Last Resort (SOLR) procedure to oversee the orderly transfer of a failed supplier’s customers to a new supplier (see below, 5. Please outline any industry-specific legislation and industry regimes relevant to managing insolvency or debt restructuring).

The key driver behind these recent failures is the unprecedented rise in wholesale energy prices. A large portion of consumers are on fixed-price contracts but their suppliers would not in all cases have hedged their exposure to wholesale price rises. In addition, there is the price cap in the retail energy market which can also prevent suppliers passing on the additional costs attributable to the wholesale price rises (though the price cap rose in April 2022 to help suppliers with these higher costs, see Legal update, Ofgem decision on default tariff price cap to apply from 1 April 2022 to 30 September 2022). This all means that those customers have been loss-making (often heavily so). The timing of these price rises in 2021 was particularly damaging from a cashflow perspective as it came when many suppliers were also having to meet their annual Renewables Obligation payments (see, for further information, Practice note, Renewables Obligation).

It was always likely that there would be some attrition in the market for smaller suppliers given the flurry of new suppliers which entered the market in the last decade or so. Nevertheless, the number of failures and the speed of those failures was unexpected. See reuters.com: Factbox: British energy suppliers dwindle as gas prices soar (1 December 2021).

2. Are current trends in R&I activity reflective of trends you have observed in this industry in the last five years or have there been any significant shifts?

We have not seen any significant shifts in R&I activity in the industry, except the number and speed of failures in the market in the last 12 months as described above.

3. The industry is facing the triple challenge of Brexit, COVID-19 and climate change. Are these factors changing the way R&I activity is being conducted in the industry?

We would not say that any of Brexit, COVID-19 or climate change has had an exceptional impact on R&I activity in this industry. The trends which those issues have caused in other sectors can also generally be seen in the retail energy industry.

For further discussion of the impact of these issues on the energy sector, see:

4. Where in the industry are you observing the most R&I activity and exposure?

See question 1. Have you seen significant restructuring and insolvency (R&I) activity in the retail energy industry in the last 12 months?.

Industry insolvency regimes and cases

5. Please outline any industry-specific legislation and industry regimes relevant to managing insolvency or debt restructuring.

Retail energy supply has its own restructuring and insolvency regime. There are two parts to this regime that are worth noting at a high-level.

The first of these is the SOLR mechanism, which, in recent months, Ofgem has used frequently to transfer a failed supplier’s customer book to a new supplier. The aim of the SOLR mechanism is to ensure that a failed supplier’s customers avoid any interruption in their supply as a result of that failure. The failed supplier will typically have their supply licence revoked by Ofgem as part of the invocation of the SOLR procedure and, thereafter, will proceed to a typical corporate insolvency process. It should be noted, however, that the use of the SOLR mechanism can complicate the subsequent insolvency process; for example, the new supplier may try to make a claim in that insolvency process in respect of certain liabilities it has incurred in honouring the customer credit balances which were transferred to it as part of the SOLR process, see 7. Please describe up to two important insolvency and/or restructuring cases in the industry and what their impact is. For further information on the SOLR procedure, see Practice note, Ofgem: roles, powers and duties: Appointing a supplier of last resort and energy administration orders.

The second part of the regime that is worth noting is the special administration process for licensed retail energy suppliers. This special administration process was used for the first time in November 2021 in relation to Bulb Energy. The procedure is more suited to large supplier insolvencies where the SOLR process is not practicable. It allows for the administrators to continue to trade the failed supplier in order to maintain continuity of supply to its customers and also, ultimately, to transfer different parts of the failed supplier’s business to separate new suppliers so that the burden of these transferred customers (which are, at present, usually loss-making for the reasons mentioned above in 1. Have you seen significant restructuring and insolvency (R&I) activity in the retail energy industry in the last 12 months?) is shared between the new suppliers. See Department for Business, Energy and Industrial Strategy (BEIS): Bulb customers protected as energy provider enters special administration (24 November 2021).

For further information on the SOLR procedure and the special administration regime, see Practice note, Q & A: which insolvency procedures apply?: Q: To an energy company?.

6. What impact is the Corporate Insolvency and Governance Act 2020 (CIGA 2020) expected to have on this industry?

We wouldn’t expect the CIGA 2020 to have an outsize impact on this industry when compared with other sectors.

The fact that retail energy supply entities are regulated and there is a specific insolvency regime in place means that, though technically possible, there will be minimal scope for these entities to use the restructuring plan or the standalone moratorium under the CIGA 2020.

Further, energy supply is one of the limited areas where there were already existing provisions in place to (among other things) protect against termination of supply for insolvency (see sections 233 and 233A, Insolvency Act 1986) and so the new measures set out in section 233B of the Insolvency Act 1986 should not have a material impact on energy supply companies (in their capacity as suppliers to insolvent counterparties; paragraph 1 of Schedule 4ZZA Insolvency Act 1986 excludes certain paragraphs of section 233B Insolvency Act 1986 from applying where the relevant provisions of sections 233 and 233A apply). Any insolvency practitioner appointed in respect of an insolvent energy supplier could benefit from the new protections in section 233B of the Insolvency Act 1986 (although, given the likely application of the SOLR mechanism to a supplier prior to it entering an insolvency process, it is questionable how useful these protections will be in practice in this context).

7. Please describe up to two important insolvency and/or restructuring cases in the industry and what their impact is.

The decision to place Bulb Energy into the first energy supply company special administration was a significant one in the industry. As mentioned above, the SOLR procedure was not deemed to be workable for Bulb given the size of its customer book (making it unviable for any one SOLR to assume the entirety of that book). Instead, the first energy supply company special administration order was sought. This application brought with it a raft of novel considerations for the court (see Legal update, Reasons given for first energy supply company administration order for Bulb Energy (High Court)).

A further interesting case is R (on the application of ScottishPower Energy Retail Limited) v the Gas and Electricity Markets Authority [2022] EWHC 37 (Admin). This entailed Scottish Power seeking a judicial review of Ofgem’s decision as to the amount of the Last Resort Supply Payment which Ofgem agreed to pay to Scottish Power in connection with Scottish Power’s appointment as SOLR of Extra Energy Supply Limited (see Legal update, ScottishPower challenge to Ofgem decision on Last Resort Supply Payment dismissed (High Court)).

Lastly, it is understood that directions have been sought from the court by insolvency practitioners appointed in this industry on a couple of significant questions:

  • Whether Ofgem is able to claim in the insolvencies of failed suppliers for outstanding Renewables Obligation payments.
  • Whether SOLRs are able to prove in the insolvency of the relevant failed supplier for their costs incurred in honouring customer credit balances transferred to them under the SOLR mechanism.

Supply chain risk

8. Where in the supply chain are you seeing the biggest areas of financial distress and insolvency risk? How is this impacting business continuity and operations in the industry?

The general answer to this question is that the industry is not immune from the supply chain issues the UK as a whole has been experiencing.

The main supplier for retail energy companies is, of course, the wholesale energy market. It is this market (and the significant price rises) which has caused the well-known issues in the industry. So, while it is not distress in the supply chain per se which is making headlines, it is the fact that the costs of supply have risen so dramatically which has caused issues.

9. How should industry participants seek to protect themselves against this risk to maintain supply chain continuity and resilience?

Unfortunately, as with all industries, there is no easy solution to supply chain risk. The right path will always depend on a number of factors, for example, sector competition or the level of exposure (both financial and commercial) a company has to a particular participant in the supply chain. Ultimately, there is no substitute for good supplier management practices.

It is worth noting that Ofgem has published an action plan which contains proposals for short, medium and long term interventions to strengthen the financial resilience of energy suppliers and to ensure that risks are not passed on inappropriately to consumers (see Legal update, Ofgem updates action plan on retail financial resilience).

Acquisition opportunities

10. Please describe trends you are seeing in distressed M&A in the industry. What areas of opportunity are there for prospective buyers of distressed or insolvent companies?

Given the current volatility of wholesale energy prices, and the losses being suffered across the industry by existing suppliers, there seems to be limited appetite for distressed M&A in this industry at the moment outside of Ofgem’s SOLR procedure (as discussed above, see 5. Please outline any industry-specific legislation and industry regimes relevant to managing insolvency or debt restructuring).

11. Are there any industry-specific risks prospective buyers should be aware of? What actions can they take to mitigate these risks?

See above, 10. Please describe trends you are seeing in distressed M&A in the industry. What areas of opportunity are there for prospective buyers of distressed or insolvent companies?.

12. How are sales of insolvent businesses generally structured in the industry?

See above, 10. Please describe trends you are seeing in distressed M&A in the industry. What areas of opportunity are there for prospective buyers of distressed or insolvent companies?.

Approaching a restructuring or insolvency process in the industry

Restructuring

13. Can you outline any industry-specific considerations and risks in a restructuring process in this industry, from the perspective of both (i) a financially distressed entity in the industry and (ii) a creditor of this type of entity?

The key stakeholder for a retail energy supply company is Ofgem. As with all regulators, they should be kept regularly updated in relation to the relevant company and the terms of the proposed restructuring.

Ofgem’s priority will be maintaining continuity of supply to customers. Ofgem and creditors will likely also want to understand how the company plans to navigate the current issues plaguing the industry. The company will need to build significant contingencies into its business plan and cashflow forecast to take account of the volatility of wholesale energy prices.

Indeed, Ofgem’s increasing focus on risk assessment is reflected in the consultation it carried out in February 2022 on changes to its guidance on applying for a gas or electricity licence. This consultation proposed changes to aspects of that guidance which clarify how Ofgem assesses an applicant’s experience and capability to manage financial risks and which enhance Ofgem’s risk assessment criteria. See Ofgem: Consultation on changes to Ofgem’s guidance on applying for a gas or electricity licence (4 February 2022).

Directors of distressed retail energy suppliers are also in a particularly difficult position as regards potential wrongful trading liabilities when a SOLR appointment is on the horizon. This flows from the fact that these suppliers will continue to receive direct debit payments for supplies even where the directors know that they are on the verge of going through the SOLR process and, thereafter, entering an insolvency process.

Lastly, insolvency practitioners should also be mindful of a supplier’s annual Renewables Obligation payment, as this can have a material impact on cashflow.

Insolvency

14. Are there any industry-specific considerations and risks to be aware of when advising (i) an entity in the industry that is going through a formal insolvency process and (ii) third parties dealing with such an insolvent entity in the industry?

By the time retail energy supply companies enter an insolvency process, they typically will already have had their supply licence revoked by Ofgem and their customer book transferred to a new operator under Ofgem’s SOLR mechanism. The exception to that general rule would be a special energy administration, used for the first time in November 2021.

As such, in many respects, an insolvent energy supply company is comparable to most other unregulated companies. However, the key point of difference is the need for the insolvency practitioner to work with the SOLR to assist with any issues arising following the transfer of the supplier’s former customers to that SOLR (including in relation to any book debts which the insolvency practitioner needs to collect).

Practitioners should also note the introduction of a new public interest business protection tax (see Schedule 10 to the Finance Act 2022) which is targeted at businesses in the energy supply sector (and, specifically, at those businesses which disposed of certain assets (including derivatives) prior to entering special administration or having a SOLR appointed in respect of its customers and where such disposal contributed to that entry into special administration or SOLR appointment). The new tax is discussed in Legal update, Finance Bill 2022: public interest business protection tax proposals tabled for Report Stage.

If you would like any further information, please contact Nick Middleton or Andrew Eaton.

This Q&A has been reproduced from Practical Law, with the permission of the publishers. For further information visit uk.practicallaw.thomsonreuters.com

Key contact

Andrew Eaton

Andrew Eaton Partner

  • Corporate Restructuring and Insolvency
  • Private Equity
  • Banking and Finance

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