Contributors
Further to our previous article, which can be found here, we consider the key issues with which the Court faced, the technical legal analysis underpinning this judgment and our view on what this may mean for energy suppliers, and the sector as a whole, looking forward.
Background - what was the application and why was it needed?
Over the last 12-18 months, there has been a proliferation of energy supplier insolvencies and Womble Bond Dickinson (UK) LLP has been instructed on the majority of them, involving a total customer book of c. 2.5 million customers. We have acted in both the pre-insolvency phase, advising the Boards of Directors of energy suppliers on their duties in distressed situations, as well as for the insolvency practitioners subsequently appointed in respect of the insolvent energy suppliers (Failed Suppliers).
This was an application by the officeholders of the Failed Suppliers for directions in relation to the treatment of certain categories of claim by two creditors, namely: (i) Ofgem (which exercises day-to-day functions on behalf of the Gas and Electricity Markets Authority (Authority)); and (ii) the Suppliers of Last Resort (SoLRs), who are the solvent energy suppliers that become responsible for supplying electricity and gas to the former customers of the Failed Suppliers.
In the case of Ofgem, the officeholders sought directions in relation to one category of Ofgem's claim being whether the Renewables Obligation[1] (RO) should be treated as a present provable debt in the estates of the Failed Suppliers (Ofgem Claim).
As for the SoLRs, the officeholders sought directions, principally, as to whether SoLRs have a provable claim in the estates of the Failed Suppliers for the credit balances of the former customers that they have assumed, paid or otherwise honoured as part of the SoLR process (Unjust Enrichment Claim).
The reason that directions from the Court were required in respect of these claims is that, in the case of the Ofgem Claim, existing primary and secondary legislation governing the RO has been sufficiently uncertain so as to leave open to interpretation whether the RO should be categorised as a present provable debt in the relevant insolvencies or a contingent claim. In the case of the Unjust Enrichment Claim, the fact pattern determining how and when a SoLR is appointed, how and when credit balances are honoured and the implications of the wider SoLR process as a whole, along with the tricky area of law of unjust enrichment, has left uncertain whether the SoLR claims should also be treated as provable debts in the respective insolvencies.
The Ofgem claim
How does the RO arise and what are the relevant statutory provisions?
Each “designated electricity supplier” (i.e. one that is licensed to supply electricity in England and Wales) is subject to the RO and pursuant to Article 7(2) of the Renewables Obligation Order 2015 (ROO15) must, by the specified day (being 1 September following the relevant obligation period), produce to the Authority the applicable number of UK renewables obligation certificates (ROCs), in respect of each megawatt hour of relevant electricity that it supplies during an obligation period (1 April – 31 March).
Designated electricity suppliers are informed, by 1 October preceding an obligation period, of the number of ROCs they are required to produce in respect of each megawatt hour of electricity that they supply to customers during that obligation period.
Designated electricity suppliers are, however, given the option to discharge their RO (in whole or part) by making a payment (buyout payment) to the Authority before 1 September in the following obligation period (Article 67(1) ROO15). The following obligation period is then defined as the “settlement period”.
The amount to be paid under Article 67(1) is a sum equal to a fixed amount for each ROC multiplied by the number of ROCs the designated electricity supplier should have, but has not, supplied to the Authority in respect of the relevant obligation period.
Where a designated electricity supplier fails to discharge its RO before 1 September in the settlement period, it has failed to discharge its RO for the relevant obligation period but it is given a grace period called the “late payment period” (article 68 ROO15). The late payment period runs from 1 September to 31 October in the settlement period. The Authority is required to notify each designated electricity supplier of the extent of its default as soon as reasonably practicable after 1 September.
If, by the end of the late payment period, the designated electricity supplier has paid to the Authority the relevant RO amount and all interest required to be paid on that amount, the supplier will be treated as having discharged its RO for the relevant period (article 68(6) ROO15).
If there is a shortfall in the amounts received by the Authority by the end of the late payment period, the mutualisation provisions contained in Articles 72 to 77 ROO15 are potentially triggered, as at the end of October in the settlement period. These have the effect of ensuring that the shortfall is paid by solvent network supplier and operate by: (1) identifying a sum to be raised (total mutualisation sum); (2) calculating the amount to be paid, and from which suppliers, towards the mutualisation sum; and (3) determining to which suppliers the sum raised is to be distributed.
Is the RO an actual, prospective or contingent liability?
The primary question before the Court was whether the RO falls to be treated as an actual, prospective or contingent liability for the purpose of proving in the Failed Suppliers' insolvencies.
A key issue between the parties on this point related to the statutory construction of ROO15 and, specifically, whether the mutualisation scheme (described in brief above) gives rise to new and different payment obligations that are intended to replace any liability that had arisen in respect of the RO.
The Court, however, held that:
"the proper analysis of the renewables obligation is that it comprises a primary obligation to provide ROCs, and a secondary obligation, to the extent that it does not provide ROCs, to make a buyout payment to the Authority…at the same time as the supplier comes under an enforceable obligation to provide ROCs, it comes under an obligation to pay money to the extent that it does not provide ROCs."
The RO liability was, therefore, categorised as follows [emphasis added]:
"Prior to 1 September, the supplier is under a contingent liability to pay, the contingency being the negative one that it has not, by 1 September, satisfied its renewables obligation by suppling ROCs to the Authority. From 1 September, the supplier is under an actual obligation to make a payment, and to pay interest for every day it fails to pay, up until 31 October. The fact that the late payment period continues until 31 October does not mean that there is no enforceable obligation to pay until that date. The payment obligation crystallises as of 1 September."
Is there a risk of double counting the RO?
The prospect of double counting, insofar as a supplier could be liable to pay the same RO amount twice (once as a continuing RO and once as an obligation beyond 31 October under the mutualisation scheme), was considered and dismissed by the Judge for a number of reasons.
In the Judge's view, one of the most compelling reasons that double counting was not in issue, was because the Explanatory Memorandum to the Renewables Obligation Order 2005 (ROO5), which introduced the mutualisation scheme, indicated that the drafter of ROO5 was aware that the most likely circumstance in which mutualisation would occur is one in which there was no double counting, because those required to make mutualisation payments would constitute suppliers other than those who had caused the shortfall. This, it was considered, had been borne out in practice since the discrepancy between the total shortfall and the total amount paid out under the mutualisation scheme, in each of the past few years, had been very small.
Furthermore, the Judge considered that:
"the fact that the continuation of liability under the renewables obligation puts the partially defaulting suppliers in the same position as fully compliant suppliers so far as the possibility of double payment is concerned, is a powerful reason in support of the continuation of that liability [the RO]…".
Is the RO a provable debt in the insolvencies of the Failed Suppliers?
In short, "yes", where the relevant suppliers have failed to discharge their RO by 1 September because, amongst other reasons, Article 68 ROO15 states that the RO will not have been discharged by a supplier who fails to make good its default in payment by 31 October and there is no express provision terminating that liability to pay under the applicable legislation.
The SoLR Claim (Unjust Enrichment Claim)
The law of unjust enrichment has been considered in a number of cases but, the claim itself, is neatly summarised by Lord Steyn in Banque Financiere de la Cite v parc (Battersea) Ltd [1999] 1 AC 221 (modified, as follows, for the energy supplier insolvency context):
- Has the Failed Supplier been enriched by reason of the satisfaction of the customer balances by the SoLRs?
- Was the enrichment at the expense of the SoLRs?
- Was the enrichment unjust?[2]
- Does the Failed Supplier have a defence?
If a claim in unjust enrichment is established, the appropriate remedy is that the SoLR is subrogated to the claims of the customers of the Failed Supplier (i.e. entitled to prove as an unsecured creditor in the insolvent estates for the credit balances assumed, paid or otherwise honoured by the SoLR).
Application of the assumed facts to the law of unjust enrichment
Based on the facts that the Judge was asked to assume as part of this application (which are common to SoLR processes more generally), he held that the payment of each of the Failed Supplier’s customer credit balances by the relevant SoLR was "implicitly requested or ratified by the Failed Supplier", in circumstances where the SoLR could reasonably expect to be entitled to claim reimbursement from the Failed Supplier. That being so, this was sufficient both to cause the Failed Supplier’s debt to customers to be discharged and to give rise to the requisite unjust factor.
As a backstop position, the Judge held that, even if the above analysis was wrong, then the SoLRs were, following their appointment, under sufficient legal compulsion to give rise both to the discharge of the Failed Supplier’s obligation to customers and to the requisite unjust factor.
The above was held to be the case, in view of the fact that:
- by entering into a licence with the Authority, suppliers agree to participate in a system in which the Authority plays a pivotal role, acting at all times in accordance with its principal objective of protecting the interests of energy consumers
- by entering into a licence, at a time when it could in due course become either a Failed Supplier or a SoLR, each supplier agrees to behave in a manner which avoids detriment to Domestic Customers, unless that detriment is in all the circumstances reasonable;
- when a supplier is facing revocation of its licence due to its insolvency, it knows that it will be unable to honour any credit balances held by customers with it and is actively involved in the process by which its customer balances are honoured by the SoLR in at least two ways[3],
such that the Failed Supplier has sufficiently acquiesced in its customer balances being honoured by the incoming SoLR, that it is to be regarded as having requested or ratified the SoLR’s actions for the purposes of giving rise to an equitable entitlement to be subrogated to the customers’ claims against the Failed Supplier.
"At the expense of", legal compulsion and the unjust factor
The Judge did not accept that the enrichment of the Failed Suppliers was incidental or collateral, such that the honouring of customers’ credit balances was not “at the expense of” the SoLR.
By contrast, the enrichment of the Failed Supplier (being the discharge of its debt to customers) was held to be "the essential consequence of the thing done by the SoLR at its cost (the honouring of customers’ credit balances)" and …"far from incidental to the SoLR’s expenditure"…nor is it merely collateral to the reason why the SoLR incurred the expenditure".
As for compulsion (being an unjust factor), the Judge rejected the proposition that, in order to constitute compulsion sufficient to discharge a debtor (D)’s debt, a creditor (C) must be able to enforce payment against a third party (TP), noting that compulsion, as an unjust factor more broadly, includes compulsion pursuant to statute (i.e. not at the behest of any particular person).
Furthermore, whilst the relevant Standard Conditions do not refer explicitly to honouring either credit balances of customers, or commitments made to the Authority, the Judge noted that they do expressly include the obligation to avoid detriment to Domestic Customers (save only where the detriment is reasonable). In view of this, given the Authority’s known preference for appointing as SoLR a supplier who was willing to give a commitment to honour customers’ credit balances, a SoLR who had made that commitment and then reneged on it would directly have deprived the relevant customers of a benefit which they would otherwise have been likely to obtain. This was considered to be "…an obvious and unreasonable detriment to those customers. The range of enforcement powers open to the Authority for breach by a supplier of the terms of its licence, which could ultimately mean the revocation of that licence, contain a sufficient element of compulsion to satisfy the enrichment and unjust elements of a claim in unjust enrichment".
Was the defence of passing on available?
The defence of passing on, which in this context might theoretically be established if a SoLR received a Last Resort Supply Payment (LRSP)[4] for honouring customer balances that it was also entitled to recover from the Failed Supplier's insolvency process, was held not arise in these circumstances on the basis that there is no case in the jurisdiction of England and Wales, to date, that has recognised a defence of passing-on to a claim in unjust enrichment (and the facts of this case did not alter that position).
What does this judgment mean for creditors, energy suppliers and the sector as a whole and what does the future hold?
This is a landmark judgment, as it is the first time that the Court has been asked to consider whether (and to what extent) the Authority and SoLRs are creditors of the Failed Suppliers for certain categories of debt in the estates of the Failed Suppliers. There is accordingly now much needed clarity in this area of law meaning that a number of existing administration and liquidation cases that have remained open while these issues are resolved will now be able to distribute to creditors and be closed.
Whilst we now have some guidance as to the treatment of certain categories of creditor claim, there remain certain statutory provisions under ROO15 where further clarification is still required.[5] This perhaps suggests that we can expect some changes to the current legislative framework when parliamentary time allows.
It is also noteworthy that this judgment has been handed down at a time when Ofgem has recently announced a number of proposals to reform the energy supplier sector. These proposals are predominantly aimed at ensuring companies are sufficiently capitalised so as to withstand any future shocks to the market. One of the proposals, it is understood, will include a requirement for suppliers to ring-fence money that they need to buy renewable energy (particularly in light of the impact that the RO has had on Failed Suppliers' cashflow insolvency and the resulting SoLR and insolvency processes). Whether or not this proposal achieves legal force will be interesting to follow both from the perspective of a Board of Directors that may need to provision for such a liability (and how that will impact their duties to creditors following the recent judgment in Sequana[6]), as well as that of the general body of creditors and whether they will see greater returns out of future energy supplier insolvency processes. Along with the proposals for ring-fencing customer credits, this would have a further impact on the working capital available to suppliers and would create a new barrier to entry for any potential new competitor seeking to enter this market.
One other key question for the directors of supply businesses is how they view the grace period. Previously, some suppliers had developed their cashflow forecasts on the basis that the RO had to be paid (with interest) by 31 October. The implications of this judgment is that the RO is due and payable on 1 September and that the grace period does not offer any protection for a supplier against Ofgem seeking to enforce that debt immediately. The implication of this judgment is that the grace period only protects a supplier against regulatory enforcement by Ofgem, not a debt action by Ofgem. As a result, where the prior crop of insolvencies mostly occurred in the period between 1 September and 31 October, in the future the timetable may be more accelerated.
Watch this space.
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[1] An obligation under energy legislation for energy suppliers to source a proportion of electricity from renewable sources.
[2] In Capital Insurance Co Ltd v Samsoondar [2020] UKPC 33,the Privy Council emphasised the importance of identifying the “unjust factor” relied upon (e.g. mistake, duress, undue influence, failure of consideration, necessity or legal compulsion).
[3] First, by providing information relating to its customer balances to the Authority and, second, by making a statement to its customers telling them that a SoLR has been appointed and that they are not to worry, but to sit tight, to ensure that the handing over of customers to the SoLR, and the SoLR’s honouring of customers’ credit balances, is as hassle free as possible.
[4] Under Standard Condition 9 of the supply licences, a SoLR is entitled, provided it has the Authority’s consent to do so, to make a claim for a LRSP from distributors. The LRSP is intended to cover certain of the costs incurred by the SoLR, including the cost of purchasing wholesale energy at short notice, and the cost of honouring customer credit balances and its cost is passed on by increased charges to suppliers and, in turn, to customers.
[5] For example, the "lacuna in ROO15" (as Mr Justice Zacaroli termed it (see paragraph 90 of the judgment)) insofar as there is a lack of statutory provision setting out what the Authority should do with any late payments made after 31 October (as compared with the detailed mutualisation framework, for example).
[6] BTI 2014 LLC v Sequana SA [2022] UKSC 25.
