Warnings of drought orders in the parched south-east have recently made headlines. But, as Cameron Timmis finds out, working as a lawyer in the water sector can cover anything from mergers and acquisitions to outsourcing and property

City firm Berwin Leighton Paisner claimed an unusual first last month when it advised Sutton and East Surrey Water on its application for a drought order – the first successful application for 11 years. The order, granted following a public hearing in March (Robert Fookes of 2 Harcourt Buildings, London, presented the case), enables the company to prohibit non-essential uses of water in the region.


Privatised in 1989, the UK water industry now consists of 25 companies: ten large water and sewerage companies, and 15 smaller ‘water-only’ companies. It is the most highly regulated of the utilities, overseen not only by the Water Services Regulation Authority (Ofwat), which is the economic regulator, but also by the Environmental Agency and Drinking Water Inspectorate. It is also subject to numerous European environmental directives, including the forthcoming Water Framework Directive.


Every five years, each company is subjected to a periodic review by Ofwat, which determines the amount of capital investment to be made by each company, and the maximum prices that can be charged to customers.


As well as dealing with the regulatory framework, water companies require expertise across many other legal disciplines, from property and litigation to outsourcing and finance.


Most large water companies have sizeable in-house legal teams. Martin Parker, head of legal affairs and company secretary at Northumbrian Water, joined the company in 1990, from Newcastle law firm Ward Hadaway. Initially involved in acquisitions work – shortly after privatisation, Northumbrian acquired a number of businesses before it was bought by French utility Lyonnaise des Eaux (later Suez, which in turn sold to a consortium in 2003) – he now oversees the company’s corporate and commercial work. Mr Parker is supported by a team of four lawyers who look after private finance initiatives (PFI), litigation and regulation, property and data protection issues.


A key aspect of the team’s work is negotiating contracts with major business customers, such as steel manufacturer Corus, which contribute a valuable share of the company’s revenue. ‘They are long-term, high-value contracts,’ says Mr Parker. ‘That has been quite challenging.’ The team also looks after PFI contracts in Scotland, property work, and litigation.


For Mr Parker, the single biggest challenge is keeping a tight rein on costs. ‘Our spend on legal services is very carefully monitored. We try to get best value in everything we do and so we are very watchful of expenditure on lawyers,’ he says. Its external advisers include local practices – Ward Hadaway, Eversheds and Dickinson Dees – and City firm CMS Cameron McKenna for banking work.


Unlike the south-east, the north-east region is not suffering a water shortage and there are no restrictions on water usage. Northumbrian Water also owns a smaller water company in the south-east, Essex and Suffolk Water, but Mr Parker says there are no restrictions planned there either: ‘The reservoirs are reasonably full and we are able to cope without restrictions… it could change, but at the moment it’s OK.’ He attributes this to ‘careful planning, various transfer schemes which bring in water, and assistance from customers in conserving water’.


Yorkshire Water (a subsidiary of Kelda Plc) also has no plans to restrict water use. Head of legal Stuart McFarlane is emphatic that the company is ‘nowhere near’ the stage of applying for a drought order. It is an area where he has some expertise – in 1995, the company successfully applied for a number of drought orders involving multiple public inquiries.


Mr McFarlane heads a group of 11 lawyers split into three teams: property, commercial and litigation. Property, with five lawyers, is the biggest group. As the second-largest landowner in Yorkshire, the company has a large property portfolio and is also acquiring new land as part of an extensive capital investment programme. Additional work involves obtaining easements to lay new pipes for water and sewerage purposes. The department also handles personal injury work in-house, some commercial litigation and defends the company in criminal prosecutions by regulators such as the Environment Agency. It also prosecutes companies for breaching trade effluent legislation.


Kelda, via subsidiary Kelda Water Services, also has operations in other parts of the UK, including a £700 million outsourcing contract for waste-water treatment in south Wales and, as of last month, a £110 million contract to build and operate four new treatment works supplying half of Northern Ireland’s drinking water.


‘We tend to get involved in these projects in joint venture. Usually we use a law firm acting on behalf of the joint venture and colleagues from my team will get involved from a Kelda perspective to make sure our interests our protected,’ says Mr McFarlane. City firm Denton Wilde Sapte, led by partner Julian Pope, advised Kelda on the Northern Ireland work, known as Project Alpha.


Like Mr Parker, Mr McFarlane says cost efficiency is the biggest challenge for his department: ‘Water companies have to be more and more efficient while improving their service. We are no different.’ One consequence is that the company outsources ‘very, very little work these days’, though its chosen advisers are Hammonds, Walker Morris, Addleshaw Goddard, Allen & Overy (for plc issues) and Berwin Leighton Paisner (for construction).


Although many legal matters and most regulatory work is handled by water companies in-house, a number of law firms have established dedicated water sector practices. Typically, these practices specialise in either corporate and finance work for water companies, or construction and PFI water projects.


City firm Herbert Smith is steeped in the industry, having handled the privatisation of the industry between 1987 and 1989, as adviser to what was then the Water Authorities Association. Since then, says Trevor Turtle, the head of the firm’s water group, it has acted for all the water companies at some time. Current clients include Bristol Water, Severn Trent and Thames Water, but its biggest piece of work relates to Northern Ireland, where the firm is advising the government on a programme to upgrade and modernise the water and sewerage system, and transfer ownership from central control to a new licensed undertaking, wholly owned by the government.


Mr Turtle says regulators are getting increasingly tough, and cites Ofwat’s new financial penalties regime, which came into force last year following the 2003 Water Act. This month, Severn Trent became the first company to be threatened with a fine – which can be as much as 10% of turnover – after failing to meet customer performance standards relating to misreporting of customer relations data. ‘The tide seems to be going one way,’ says Mr Turtle. ‘There’s been an increased emphasis on enforcement and compliance and regulators are becoming more stringent in their application of the regime… that seems to be the trend at the moment.’


Herbert Smith, like many other City firms, has also benefited from substantial merger and acquisitions activity in the sector. The firm is currently advising on Severn Trent’s disposal of its sewerage business Biffa.


The biggest transaction expected this year is the sale of Thames Water, the UK’s largest water company, by German parent RWE. As with many recent sales of water companies, financial institutions are the front-runners to buy the company – private equity house Terra Firm and Australian bank Macquarie have been reported as potential bidders. Under the current regime, water companies are generally prohibited from acquiring competitors, except smaller water-only companies, though experts suggest the Competition Commission may be relaxing its stance.


‘The thing about water companies is that they are quite attractive to financial institutions,’ says Charles Bankes, a competition partner at City firm Simmons & Simmons, who advised French utility Veolia on its attempted bid for Southern Water. ‘The revenues are pretty bomb-proof, as long as you get the engineering right.’


As a result, says Mr Bankes, the ownership of UK water companies has become increasingly dominated by ‘financial people’. Financial institutions that now own water companies include Royal Bank of Scotland (the majority shareholder in Southern Water), Macquarie Bank (South East Water) and the Bahrain-based First Islamic Investment Bank (South Staffordshire Water).


As well as advising on sales and acquisition of water companies, many law firms specialise in advising on large water projects. Many of these are international – Pinsent Masons, a leading firm in this area, is particularly active in Middle East and Hong Kong. One area of expertise is desalination plants – the firm is acting for a party to the construction consortium in a $2.4 billion desalination project in Saudi Arabia.


Mark Lane, who heads the firm’s water sector group, tips desalination as one of the ‘big markets’ in the coming years, citing Thames Water’s plan to build a desalination plant in Beckton, east London – currently the subject of a planning inquiry – as a sign of things to come. He says: ‘The simple fact is if we don’t have enough water in the south-east – we have to get it from somewhere. The answer is [to get it] from the sea.’


Cameron Timmis is a freelance journalist