GAS and Electricity Markets Authority v GB Energy Supply Ltd

This is an application brought by the claimant, the Gas and Electricity Markets Authority (“GEMA”) acting through the officials of OFGEM for a declaration that the defendant company GB Energy Supply Ltd is unable to pay its debts and therefore conditions in the relevant Electricity Supply Licence and Gas Supply Licence, whereby GEMA authorises the defendant to operate as a gas and electricity supplier in the UK, are satisfied. If those conditions are satisfied then under the terms of the relevant licences GEMA can revoke the supply licences and appoint another energy supplier as a Supplier of Last Resort.

The matter has been heard out of hours on the evening of Saturday 26th November 2016. The hearing was conducted on the telephone. Nicholas Cox and Lara Hassell instructed by OFGEM acted for GEMA. Also on the telephone conference call hearing was Mr Bates of Addleshaw Goddard representing the defendant. As is explained below the matter was very urgent and therefore it was appropriate to deal with it in that way. This judgment sets out the reasons for making the order I made on that Saturday evening.

The Application was supported by a witness statement of Mr Robert Philip Salter-Church of OFGEM. He was authorised to make his statement on behalf of OFGEM and GEMA. For convenience in this judgment both GEMA and OFGEM will be referred to as the Authority.

As Mr Salter-Church explains the Authority is the independent regulator for the gas and electricity markets established by the Utilities Act 2000. It is funded largely by the network companies which are licenced by the Authority to participate in the gas and electricity markets. The Authority consists of non-executive and executive members appointed by the Secretary of State of the Department for Business, Enterprise and Industrial Strategy (“BEIS”) and a non-executive chair who oversees the work and provides strategic and policy direction. OFGEM stands for the Office of Gas and Electricity Markets. It is a non-ministerial government department and an independent national regulatory authority. It is governed by GEMA and carries out the day to day functions necessary to enable GEMA to discharge its functions. GEMA’s functions are, so far as relevant, provided under the Gas Act 1986, the Electricity Act 1989, the Utilities Act 2000 and measures set out in a number of Energy Acts, including the Energy Act of 2004 and 2011.

The principal objective of the Authority when carrying out its functions is to protect the interests of existing and future electricity and gas consumers. In relation to the supply of electricity the Electricity Act 1989 (as amended) provides at section 3A that:-

“3A. (1) The principal objective of the Secretary of State and the Gas and Electricity Markets Authority (in this Act referred to as the Authority) in carrying out their respective functions under this part is to protect the interests of existing and future consumers in relation to electricity conveyed by distribution systems or transmission systems.

(1A) Those interests of existing and future consumers are their interests taken as a whole including ……..

(b)

their interests in the securing of the supply of electricity to them.”

In similar terms the Gas Act section 4AA (as amended) sets out the principal objective of the Secretary of State and GEMA in relation to the gas conveyed through pipes and the security of supply of gas to existing and future customers. The Authority is also concerned to promote effective competition in the relevant market and to have regard to the interests of consumers and the protection of those interests when it carries out its functions.

Companies that produce or import energy, e.g. electricity generators and gas producers, sell their energy in the wholesale markets. Companies that consume energy, such as large industrial organisations or companies with customers who consume energy (e.g. retail suppliers), buy the energy they need in the wholesale markets. These wholesale markets are based on the principle that market participants balance their own physical and traded positions. This balance is a combination of what physically flows in and out of the networks and what the participants contract to buy and sell.

Trading is the primary mechanism by which market participants address a potential imbalance between their physical positions. The System Operator (“SO”) carries out a residual role in which it resolves any imbalances and location issues that remain after the market has run its course i.e. close to or in real time. The SO for gas is National Grid Gas while the SO for electricity is National Grid Electricity Transmission.

The balancing mechanism on the electricity transmission network is designed to maintain an energy balance on the network in real time. It provides National Grid with tools to accept bids and offers to buy and sell electricity at short notice in case of imbalance. It also creates incentives for generators and suppliers to contribute to the balancing of the system, for instance it penalises those causing an imbalance. When market participants fail to balance their own position they must pay imbalance or cash out charges. Where the SO has to intervene these charges are set based on the marginal cost of SO actions to balance the system. These imbalance charges are set at a level which incentivises suppliers to balance their positions. In the gas market there is a corresponding arrangement for balancing and imbalance charges.

If a supplier fails completely, imbalance charges which cannot be met through the insolvency process are mutualised across supply market participants. In his witness statement Mr Salter-Church gave more details of the electricity and gas trading arrangements in the market but it is not necessary to deal with them in any further detail.

The regulation of the supply to consumers of gas and electricity is provided for in the Gas Act 1986 and the Electricity Act 1989. This operates through the imposition of a licensing requirement and the enforcement of licensing conditions. Licences are the primary means by which OFGEM regulates and enforces obligations placed on the relevant operators in these sectors.

The main part of any energy licence consists of a Standard Licence. Individual licences contain various schedules and in the present case Schedule 2 to each licence sets out the conditions on which the defendant’s licence is revocable by the Authority. Until it is revoked the effect of the supply licence is that the supplier is under a continuing duty to offer to supply energy to its domestic customers (see e.g. Electricity Supply Standard Licence condition 22.2 and 22.3). Suppliers are also required to maintain a daily balanced position between their supply to customers and the supplies they must obtain in the market. Licensees are also able to volunteer to be or be directed by the Authority to act as a Supplier of Last Resort in circumstances where another licence holder has had its licence revoked in order to maintain continuity of supply to customers.

GB Energy Supply Ltd was granted an Electricity Supply Licence under section 6 of the Electricity Act on 7th April 2013 and a corresponding Gas Supply Licence on the same day. These licences refer to Altitude Energy Supply Ltd which was its former name until 7th October 2014.

Mr Luke Watson is the CEO of the company. In the evidence before me was a copy of witness statement which Mr Watson had sworn in support of a pending application by the company issued in the Leeds District Registry of the High Court. I refer to that application below. Mr Watson’s evidence explains that the company has about 139,000 domestic electricity customers, about 101,000 domestic gas customers and also supplies gas and electricity to about 990 small and medium sized enterprises. It supplies into the main UK market, excluding Northern Ireland. In financial terms this customer volume represents about £100 million in annual sales.

Mr Watson states that the company is not vertically integrated and has no generating capacity of its own. It is required to purchase all electricity and gas for consumption by customers from other participants in the wholesale market. He describes the company as a “virtual” energy supplier, which means that the majority of its operational requirements are outsourced to third parties. Notably this includes the provision of customer facing operations, in other words its call centre.

This Application arises because of the financial difficulty in which GB Energy Supply Ltd has found itself. On 21st October 2016 the Authority was first notified that the company anticipated being in financial difficulties in mid December of this year. The company provided periodic cash-flow updates which indicated that the company would experience a negative cash position in the week commencing 12th December. Since 21st October the company and its advisors BDO LLP had been attempting to achieve a sale of the business. These efforts continued up to Thursday 24th November.

At a telephone call at 10am on 25th November 2016 (Friday) the Authority was informed that it had not been possible to achieve a sale of the business and was also informed that a provider of call centre services to the company was threatening to withdraw its services at short notice. These matters were set out in a letter from the company to the Authority dated on Friday.

At 5pm on Friday the company disclosed to the Authority that it had been advised to and had issued an Application in the Leeds District Registry of the High Court for permission to pass a resolution for voluntary winding up. An electronic copy of that Application which explained that insolvency practitioners at BDO were to be appointed liquidators of the company was received by email at the Authority at 5.30pm on Friday. That application was supported by the witness statement of Luke Watson, the CEO of the company. Mr Salter-Church’s information was derived from information provided in that statement and in other information provided by the company to the Authority pursuant to section 34 of the Gas Act 1986 and section 47 of the Electricity Act 1989 and Standard Condition 5 of each of its Supply Licences.

A summary of the financial and cash-flow position of the company was provided by a letter dated 26th November 2016 from the company’s advisors and proposed liquidators BDO LLP. Their professional opinion is that the company is insolvent within the meaning of section 123 of the Insolvency Act 1986 both on a cash-flow and balance sheet basis.

On the basis of all this material Mr Salter-Church’s view is that the company is currently unable to pay its debts.

Under section 161 of the Energy Act 2004 as it applies pursuant to section 96 of the Energy Act 2011 there are restrictions on a voluntary winding up of an energy supply company. Under the section an energy supply company has no power to pass a resolution for a voluntary winding up without permission of the court. Permission will only be granted on an application made on notice to the Secretary of State and to GEMA, and by section 161(3)(b) a period of at least 14 days must have elapsed since service of the last of the notices on the Secretary of State and on GEMA. Therefore the court cannot give permission to the company to pass a resolution for voluntary winding up until the 14 day period has elapsed. There is no express provision for that period to be abridged by consent. Sections 160, 162 and 163 of the Energy Act 2004 impose a corresponding 14 day period in relation to other forms of formal insolvency procedure.

Mr Salter-Church explained that this is the first energy supply company which has become insolvent since the coming in to force of the regime and the meaning and effect of that subsection has not been considered by the court. The other the grounds on which the Authority might have revoked an insolvent company’s licence would also require the completion of the process to put that company into a formal insolvency procedure.

Mr Salter-Church explained that the problem for the Authority is that it believes the circumstances are sufficiently urgent that waiting for 14 days to elapse will cause significant difficulties. This is on two grounds: the effect on other market participants in the energy markets and the effect on consumers.

Considering the market participants, as long as the company has an energy supply licence it remains liable for the supply of energy to its customers and for the cost of that supply together with the cost for compliance with other industry and environmental and social schemes. However, given the company’s finances it is unlikely to be able to enter into any further transactions with other energy market participants in order to purchase sufficient energy (electricity or gas) to balance its outflow requirements. This is due to its limited cash reserves and the limitations on its ability to use inflows of cash, specifically direct debit payments, for working capital purposes. To the extent the company is unable to balance its own position the SO will carry out its residual balancing role and the price which the company will be required to pay when the SO does this will be higher than if the company had been able to procure its own energy to meet its outflows. The level of that price is likely to be very volatile. Should this happen, given that the company’s cash is exhausted, these costs will fall to be taken up across the other industry participants.

Furthermore and irrespective of the obligation under the licence to continue to offer to supply, in practice until the company’s contracts have been transferred or deemed to have become contracts with a Supplier of Last Resort established to replace the company, there is no practical way to prevent existing customers from taking electricity or gas from the network. The cost of this supply would again be spread across the rest of the industry.

It is not easy to quantify how these costs will be redistributed and in what amounts given that the charges imposed on the company will depend on a range of factors including the wider market circumstances at the relevant time. Nevertheless, Mr Salter-Church explains that using one method of estimating the likely liability arising from the continued trading of the company, the Authority believes that the cost could be in excess of £6m over the 14 day period. The Authority is very concerned about the possible impact on other small energy supply companies of the effect of spreading costs of that magnitude across the industry. In other words, the Authority’s concern is that the company’s financial difficulties carry a severe risk of a knock on effect to the financial position of other small energy supply companies in the market if the company remains in the market for a further 14 days.

The other matter which the Authority is concerned about is the risk that a lack of urgent intervention will materially damage consumer trust and confidence in the energy market. If the company’s call centre provider withdraws its services that will leave the company’s customers unable to contact it when information about its position comes in to the public domain. At the time I was first notified about this application on Saturday afternoon the details were not in the public domain but between then and the telephone hearing which took place about 3 hours later information was beginning to be made public.

The Authority is concerned that problems of that kind experienced by the company’s customers have the potential to have ramifications for the whole UK retail energy market. A prolonged period where the company’s customers are unable to contact it and it was not possible for the Authority to put in place a Supplier of Last Resort to move customers to a new supplier would attract significant negative media attention. This could lead to a breakdown in trust in the market particularly focussed on smaller suppliers operating in that market. If the customers of a smaller energy supplier cannot contact their supplier when something has gone wrong, customers would fear that these kinds of energy suppliers were not secure. The Authority’s particular concern is that this might lead customers who are not supplied through the six large former regional monopolies to switch back to those companies because of their perception that those larger suppliers carry a lower risk than the smaller suppliers of which the company is an example.

Mr Salter-Church explained that a perception of that kind could further destabilise the finances of the smaller suppliers with a knock on effect on the financial position of these smaller suppliers. In the longer term a collapse in confidence of smaller suppliers would be detrimental to the consumer’s interests in the entire UK retail energy market. The Authority has been trying over recent years to increase competition in that market and in particular to allow competition from small suppliers. The percentage of small suppliers has grown from about 1% in 2012 to 14% in 2016. A retreat by customers back to the former regional monopoly providers would erode the benefits that have been difficult to achieve reducing competition in the market and create worse outcomes for all UK energy consumers. If swift action can be taken to resolve this issue and provide broader confidence to all energy consumers this would mitigate these risks.

Mr Salter-Church explained that in parallel with making this application other officials at the Authority are looking to make a controlled announcement about the matter to stabilise the position of the market and maintain public confidence.

For all these reasons the Applicant wishes to use whatever lawful means are available to avoid a prolonging period of uncertainty in the energy markets.

By the application the Authority is seeking a declaration concerning the financial state of the company. That is that the company is unable to pay its debts within the meaning of the Insolvency Act 1986. If that is the case then the Authority will be entitled to revoke the company’s licences on the relevant ground. The Authority will then be able to appoint a Supplier of Last Resort because under the Standard Supply Licence condition 8.1 for both gas and electricity upon revocation of a failed supplier’s licence the Authority can direct any gas or electricity supplier licence holder to take overall responsibility for that failed supplier’s customers (i.e. to be a Supplier of Last Resort).

The Authority has published recent guidance on the manner and circumstances in which it expects to exercise these powers (“Guidance on supplier of last resort and energy supply company administration orders” dated 21^st October 2016). The Authority’s preferred option is a trade sale of a distressed supplier’s business but if that is not feasible then the Authority expects first to exercise its powers to revoke the licence and then to appoint a Supplier of Last Resort. Only when the power to appoint a Supplier of Last Resort is not feasible will the Authority consider seeking the consent of the Secretary of State to make an Application for an Energy Supply Company Administrator to be appointed under the Energy Act 2004 and 2011. These priorities are summarised in the overview part of the Guidance as well as the executive summary (and see also paragraph 1.26).

The Authority has consulted with the BEIS in relation to this application. In a letter dated 25^th November 2016 John Fiennes, Director of Energy Strategy, Networks and Markets in the Department, expresses the Department’s support for the approach being taken by the Authority. The letter explains that the Supplier of Last Resort regime is the preferred option from a policy perspective and is suitable for dealing with the vast majority of suppliers, including a small supplier such as the defendant. In the Department’s view the exception would be for a supplier which was one of the “Big Six” energy suppliers in the market or possibly some of the larger intermediate sized companies but this case is not concerned with one of those.

Officials at the Authority have taken a number of preparatory steps in relation to the appointment of a Supplier of Last Resort by making sure that they are prepared to issue accurate information to the network companies and industry central service providers and to facilitate the orderly appointment of a Supplier of Last Resort in this case. Based on recent information Mr Salter-Church anticipates that a number of large and medium energy suppliers will wish to volunteer to act as Supplier of Last Resort in these circumstances. Accordingly he explains that if the court is able to make the declaration sought the Authority will be in a position to make a regulatory intervention to revoke the licence, issue a Supplier of Last Resort direction swiftly and minimise the adverse impact on the industry and on consumer trust and confidence.

The Authority is seeking to take these steps within a time frame which would enable another supplier to be in place as a Supplier of Last Resort by Monday 28th November 2016 or possibly even earlier.

As the guidance referred to above explains, an alternative course open to the Authority would be to apply for an Energy Supply Company Administration Order under chapter 3 of the Energy Act 2004 as applied by section 96 of the Energy Act 2011. However, Mr Salter-Church explains that although the Authority believes the conditions for making such an application also exist, the Authority’s view is that the most appropriate intervention in this case, if it can be achieved in a timely fashion, is by revocation of the licence and appointment of a Supplier of Last Resort. This is because it is more efficient and cost-effective and also because it is consistent with the Authority’s published guidance mentioned already and the policy objectives of the Department explained in the letter from John Fiennes.

By the application the Authority asks the court to make a determination of the question of whether the company is able to pay its debts.

With that background I turn to deal with the application.

I will start by considering whether I should entertain an application of this kind in this way. That question has a number of dimensions which interrelate. I will start with the question whether the court should facilitate this approach based on an extremely urgent out of hours declaration, with its attendant consequences, rather than requiring the Authority to apply for an Energy Supply Company Administration Order. I am satisfied that this is an appropriate course to take for three reasons. The first is because I am satisfied that it is an approach which is lawfully open to the Authority (see below). The second is that the Authority is best placed to assess the most appropriate steps to take to fulfil its statutory objectives. The evidence shows that the Authority has considered the matter and decided, supported by BEIS, that this is the best approach. The third is that the Authority’s published guidelines indicate that this is approach it will take in these circumstances and so market participants and the public can have a legitimate expectation that this is what the Authority will do.

The second dimension is whether this application is capable of having the result sought by the Authority. I am satisfied that this application is capable of achieving the desired result for the reasons already addressed above. In other words if the company is unable to pay its debts then I find that it follows that the Authority has the power to revoke the licences forthwith in accordance with their terms and appoint a Supplier of Last Resort.

The third dimension is the procedural one - can or should the court deal with this matter in the extremely curtailed manner which the Authority seeks? This Application has been brought by a Part 8 Claim which will in fact not be issued until Monday. Nevertheless the Court has jurisdiction to deal with the application on the undertakings provided by the Claimant to issue and serve the Claim Form and confirm the truth of the evidence in the witness statement.

Counsel canvassed the possibility of making a formal interim declaration but it seems to me in a situation like this an interim declaration would not be the right thing to do. If a declaration of this kind is made with the consequences that it is intended to have, it is important that the matter is dealt with on its merits as a final matter. If that was not possible then I very much doubt such a declaration should be made at all.

It is convenient to refer to the matter before me as an application but I should consider whether the final nature of the relief sought means that the hearing should be dealt with in court rather than on the telephone (c.f. applications under CPR r23 by telephone under PD23A para 6). The general rule is that trials are to be in public (CPR r39.2). None of express exceptions in r39.2(3) or the exceptions in PD 39A para 1.5 apply. Nevertheless I decided that it was appropriate to deal with this application in this way. If the matter was to be dealt with, it needed to be dealt on that Saturday evening. The problems of the defendant were about to become public. If the matter were to have been dealt with in the court room it would not have been any more public than the telephone hearing in any real sense. The public would have no notice that anything was taking place either way. The recording of the telephone hearing is not private and the reasons for making the order are set out in a public judgment. I do not in any way diminish the vital importance of justice in public but it would be simply a disproportionate gesture to require the parties to attend court on Saturday evening rather than deal with the matter by telephone, with the attendant cost, real inconvenience and delay which would be caused.

Fourth, on the facts I am satisfied by the evidence that this is an urgent matter which needs to be resolved as soon as practicable, which in this case means on Saturday evening. I accept the Authority’s evidence about the risk to the commercial energy market and the risk to consumer confidence in the retail energy market. These are powerful reasons why, if this matter can be resolved in this way, it should be. An important point is that there is no dispute at all about the parlous state of the defendant company’s finances. The directors of the company are anxious to cooperate with the Authority to minimise the adverse consequences for the company’s creditors, customers and the energy supply market as a whole.

I turn to consider the substantive declaration. The issue begins with an examination of the terms of the licences between the Authority and the company. Those licences contain a term at Schedule 2(1) (f) as follows:-

“Schedule 2

Revocation

(1)

The Authority may at any time revoke the licence by giving no less than 30 days’ notice (24 hours’ notice, in the case of a revocation under sub-paragraph 1(f)) in writing to the licensee:

[…]

(f)

if the licensee:

(i)

is unable to pay its debts within the meaning of section 123 (1) or (2) of the Insolvency Act 1986, but subject to paragraphs 2 and 3 of this schedule) or has any voluntary arrangement proposed in relation to it under section 1 of that Act or enters into any scheme of arrangement (other than for the purpose of reconstruction or amalgamation upon terms and within such period as may previously have been approved in writing by the Authority);

[…]

(2)

For the purposes of sub-paragraph 1 (f)(1), section 123 (1) (a) of the Insolvency Act 1986 shall have effect as if for “£750” there was substituted “£100,000” or such higher figure as the Authority may from time to time determine by notice in writing to the licensee.

(3)

The licensee shall not be deemed to be unable to pay its debts for the purposes of sub-paragraph 1(f)(i) if any such demand as is mentioned in section 123(1)(a) of the Insolvency Act 1986 is being contested in good faith by the licensee with recourse to all appropriate measures and procedures or if any such demand is satisfied before the expiration of such period as may be stated in any notice given by the Authority under paragraph 1.”

As Mr Salter-Church points out the Insolvency Act sections 123 (1)(e) and (2) each include matters being proved to the satisfaction of the court as part of defined ways in which a company is or is deemed to be unable to pay its debts. Under s123(1)(e) that is defined by reference to an inability to pay is debts as they fall due and under s123(2) it is defined by reference to the value of its assets being less than its liabilities. In the light of these provisions the view currently taken by the Authority is that it is not its function to determine if the supplier is “unable to pay its debts” and so the Authority would prefer to generally wait until a court has made a decision before deciding whether to revoke a licence. I can see that if the Authority wishes to rely on either s123(1)(e) or s123(2) as the basis for the company being unable to pay its debts then a court decision would be necessary but there are other limbs to s123(1) and without having heard full argument on the point it is not necessary for me to grapple further with that issue.

The evidence of Mr Salter-Church, based as it is on Mr Watson’s evidence, is that the defendant is unable to pay its debts within the meaning of the relevant provisions of the Insolvency Act 1986. Before me the company is represented by Mr Bates and he also confirmed expressly that this is so.

The BDO letter of 26^th November 2016 explains the cash-flow forecasts. In a week’s time (w/c 5^th December) the company’s cash-flow forecast shows a funding requirement of £192,456 arising in that week rising to £2.97m in the w/c 12^th December and £7.9m in w/c 26^th December. Its sole source of income is direct debit receipts however given that the directors have been given legal advice not to accept any further direct debits the company will have no income from Monday, 28^th November. The only cash available is £2.6m but again the directors have been advised to ring fence that for the benefit of creditors. The call centre services supplier is seeking full or part payment of some £730,000 and absent agreement it can withdraw this service for customers. The company has outstanding trade creditors of £4.35m as at 25^th November 2016 but without future income it has no prospect of meeting these liabilities. For these reasons BDO’s opinion is that the company is insolvent on a cash-flow basis. BDO also express the opinion that the company is insolvent on a balance sheet basis, with net liabilities of £7.8m.

In my judgment the defendant is clearly insolvent. The company’s situation has deteriorated rapidly over the last 24 hours now that all the bidders have withdrawn from the sale process. In all probability the company will cease to have enough cash to function as early as Monday 28^th November 2016.

The declaration sought consists of three matters: first that the company is unable to pay its debts, second that the condition set out in Schedule 2 (1)(f)(i) of each of the licences is satisfied and third that the latter follows from the former. I am satisfied that it is appropriate for the court to make a final declaration in those terms.