Carillion’s recent troubles appear to have started last summer, when in a difficult 5-months it lost both its Chief Executive and Finance Director, issued three profits warnings and ultimately saw its share price drop by 90%. Despite these apparent signals of a company with major issues to contend with, it did not stop it winning significant contracts, including a major slice of HS2, MoD work and another major rail project. Although the post-mortem will take months to reach a conclusion, Carillion’s problems seem to go further than the current prominently reported suggestions of issues with corporate governance in the upper echelon.
Even without management and stock market convulsions, the underlying business is reported to have been struggling with three huge contracts where problems were brewing. The trade press reported on problems with multiple projects in the Middle East in July last year. The Royal Liverpool Hospital (£350m), scheduled to open in March 2017 remains a building site. A similar story can be told in the Midlands, where the Midland Metropolitan hospital (£335m) will be six or more months late. Up in Scotland, the Carillion backed consortium constructing the Aberdeen Western Peripheral Route (£745m) has run into significant difficulties and costs have spiralled. At this scale, one badly performing project would be a significant drain on resource and management time, but three major projects in trouble at the same time was always going to be difficult to manage. Whether or not the problems on these projects were of themselves enough to sink the business, or whether Carillion’s warnings over the Summer about Brexit stifling its business were underplayed, remains to be seen.
Its rapid increase and reliance on debt will no doubt be a major factor. As widely reported,Carillion’s net debt to equity ratio rose from 15% in 2012 to 30% in 2016. An analysis undertaken for Sky News claims that, taking the most negative view of its pension’s liabilities, Carillion’s liabilities were close on £5bn. When it entered into liquidation it held about £29m in the bank.
It’s clear from the scale of the business that the liquidation of Carillion is a major event in the UK construction sector with significant knock on effects for the wider industry. When a £5bn revenue company, responsible for the delivery of strategically important UK assets fails, reaching questions are bound to be asked about how it found itself in that position. Moreover, how and why Government in particular continued to award them contracts worth hundreds of millions of pounds even after it issued its first profits warning. It has now been confirmed that on the day it liquidated, Carillion was the main contractor on 57 construction projects worth a total of £5.7bn.
The far-reaching consequences of the collapse will likely impact Carillion’s 20,000 employees in the UK and up to 43,000 worldwide, though we have seen that some staff have managed to keep their jobs as the business is carved up. Inevitably there will also be hard times ahead for the industry and in particular Carillion’s supply chain, said to include as many as 30,000 firms. Any monies owed prior to the 15th January are likely to be lost forever, bringing further headaches to firms already struggling with Carillion’s draconian payment terms. Some may even fail as a result. The consequences for Carillion’s pension fund and those who have to rely on it are also significant, as will be its impact on the pension’s lifeboat, the Pension Protection Fund, which could face the need to support as much as £900m.
There are already serious lessons to be learned coming to light. Yet, just last week, Capita reported a surprise profits warning amid a suggestion that it will miss its profit target by a hundred million pounds or more. The subsequent halving of it’s share price, and signalling the possibility that their procurement and supply chain management service, Constructionline, may be sold off to cut costs, worried investors about what the future might hold.
Government are emphasising that they do not believe that Capita will be “the next Carillion”; if nothing else the timing is deeply unfortunate. On initial blush, it is hard to look too far beyond the similarities - a £1bn+ debt pile, heavy reliance on Government contracts and a pension fund in deficit close to £400m. It could also be considered that both companies have placed excessive emphasis on acquisitions to drive growth.
Against this backdrop it is unsurprising that Griffiths & Armour have fielded a number of questions from clients who have been affected, asking our advice on a range of issues from contractual documentation, fees and the payment of sub consultants to ongoing claims. With more than 3,000 clients across the construction sector, we are keen to share the learnings and identify ways to mitigate the risks in the best way possible. By doing so we can all contribute to building a more sustainable industry where overall risk is more effectively and appropriately managed and funded.
10 relevant issues for Consultants…
Many of the issues that our clients are raising have little to do with insurance. They raise problems which have commercial and legal considerations, some of them potentially of a very complex nature, and which will be for lawyers and accountants to advise. As ever, there are some steps that can be taken to mitigate potential future exposures and perhaps try and secure more than would otherwise be recovered in the liquidation:
Given that consultants’ rights and obligations will generally be contained within the contractual documentation signed... (read more)
Given that consultants’ rights and obligations will generally be contained within the contractual documentation signed with Carillion, it will be critically important to collate this documentation and review it to consider the implications. For example, what the contract provides for on such things as termination on insolvency; the ownership of intellectual property rights; whether rights to suspend licences exist for non-payment; and what provision (if any) is made to provide warranties to third parties, where you are not paid.
Importantly, absent contractual provisions providing for termination on insolvency, the fact that Carillion has started the liquidation process does not mean that agreements are automatically terminated and that you can simply walk away. Consultants need to carefully check the contract for such obligations and seek legal advice, where required.
We are clearly sensitive to the potential negative impact on consultants and their subsequent need for our understanding and support... (read more)
We are clearly sensitive to the potential negative impact on consultants and their subsequent need for our understanding and support.
If you are owed fees in respect of work undertaken prior to appointment of the liquidators, it seems to be a widely held view that you are likely to get very little, if anything, back. Providing that you make contact with the liquidators and prove details of fees owed, you will become unsecured creditors to Carillion and will be placed in the pool (along with all the other unsecured creditors) to receive whatever is left at the end of the process. Certain creditors will have priority over others, but it is very unlikely that you will enjoy any form of priority. That said, it’s important that you follow the process to ‘lodge’ your claim, otherwise you might get nothing at all.
The liquidators have stated that suppliers will be paid for services supplied from the date of the appointment (i.e. 15th January) and each supplier will be contacted in the coming weeks. Even so, it would be wise for those consultants who continue to provide services to check with the liquidators that they are going to be paid on each contract they had with Carillion. If confirmed by the liquidators, this might have an impact on considerations around terminating the contract, though if consultants are already owed significant amounts, the value these subsequent services might not be the most material consideration.
Consultants who have been appointed by Carillion may, in turn, have appointed sub-consultants to undertake some of the work... (read more)
Consultants who have been appointed by Carillion may, in turn, have appointed sub-consultants to undertake some of the work. An exception to the ‘paid when paid’ ban under the Construction Act is ‘upstream insolvency’ (i.e. the current situation). Providing that the contract makes provision for fees payable to sub-consultants being withheld in such circumstances, then it is likely that consultants could lawfully resist paying and therefore avoid being even more out of pocket. If considering this route, you should take specific legal advice before you embark upon it as mistakes could be costly.
Again, the contract should be checked to see what rights of termination on insolvency are included, what the procedures for doing so... (read more)
Again, the contract should be checked to see what rights of termination on insolvency are included, what the procedures for doing so are and whether this is in a firm’s commercial interests. The consequences of terminating a contract are not straightforward and if the procedure is not correctly followed, considerable liabilities can attach. Again, specific legal advice is recommended.
Given that a consultant’s biggest ‘asset’ will be the IPR in the designs and work provided to Carillion, if this licence can be... (read more)
Given that a consultant’s biggest ‘asset’ will be the IPR in the designs and work provided to Carillion, if this licence can be withheld or withdrawn, this may leave them in a stronger bargaining position to try and recover fees owed. The insolvency practitioners are trying to maximise the assets available to Carillion and they can pay consultants fees to gain ‘saleable’ rights that those assets might bring.
Whilst the work that those IPR relate to is likely to be in the possession of consultants, it’s possible that for projects in a centrally stored project ‘digital environment’ (i.e. a Carillion owned server) that clients might lose access to them. Steps should be taken by consultants to ensure that they retain access to such information, which may involve nothing more than asking for access, or it might mean that legal proceedings are required.
If third parties demand collateral warranties from consultants on existing Carillion contracts, they might be able to resist providing... (read more)
If third parties demand collateral warranties from consultants on existing Carillion contracts, they might be able to resist providing these if Carillion have not paid consultants fees. The potential importance of this is obvious, but advice should be taken as getting it wrong could incur costs.
Similarly, if there are requests or requirements for collateral warranties, there are clear benefits in insisting on ‘net contribution’ provisions. Of course, the merits of such provisions have been central to our long-standing risk management advice and this scenario serves as a clear illustration of their continued relevance and equitable nature.
We are aware of claims against consultants where Carillion are identified as the claimant. More might come to light on those... (read more)
We are aware of claims against consultants where Carillion are identified as the claimant. More might come to light on those matters where Carillion are further up the contractual chain and a consultant has become involved as a sub-consultant to a third party.
Carillion’s attitude to pursuing these claims may change and the liquidators will likely pick and choose their targets based on maximising recoveries. This could mean that they will be more likely to settle for reasonable sums, and more likely to ‘ignore’ lower value claims.
Any claims live prior to liquidation are unlikely to just go away, but a more favourable outcome might be achievable.
We have seen copies of letters from the liquidator essentially asking consultants to carry on providing their services and they’ll... (read more)
We have seen copies of letters from the liquidator essentially asking consultants to carry on providing their services and they’ll get paid in accordance with the terms of their original appointment for any amounts that become due after the 15th January. It specifically rules out paying fees that have become due prior to this date. There will be a significant commercial angle, but how consultants respond to the letter could impact any future legal remedies they might have and they should take advice from their solicitors as to how to respond.
It is likely that certain contracts held by Carillion will be sold on, which potentially gives consultants an opportunity... (read more)
It is likely that certain contracts held by Carillion will be sold on, which potentially gives consultants an opportunity to review and revise current contract terms. Whilst this opportunity clearly cuts both ways, there might be an opportunity to review onerous contract terms with a new ’employer’ to introduce more favourable terms, such as financial caps, less onerous indemnities and, perhaps, a greater level of fee.
It is now widely reported that Carillion was operating at sub-marginal levels. As a consequence of this and their scale... (read more)
It is now widely reported that Carillion was operating at sub-marginal levels. As a consequence of this and their scale, it could be argued that they were having a distorting effect on the market – dragging it down, if you like.
Similarly, it is questioned whether Government was procuring construction at below marginal cost, evidencing a need to enhance the level of understanding on the true price of construction and the cost of risk.
These combined factors potentially create the environment for a positive bounce in the sector. That would appear to be in the long term interests of all parties focused on a vibrant, productive and increasingly collaborative construction sector that can deliver projects on time, on budget, with appropriate profits and, above all, safely.
The most common query received from employers…what about my contractual recourse?
As it stands today an employer on a number of on-going and completed projects may face gaps in their perceived contractual safety-nets due to the imposition of liability on Carillion; they now face the prospect of that liability being worthless. It is possible that latent defects insurance may be a way for employers to protect themselves and potentially fill those gaps. We have urged employers to get in touch if they require immediate insurance or risk management assistance as a result of the Carillion liquidation.
If you have any questions relating to this article or would like to discuss the subject matter in more detail, please get in touch using the contact details below and we will be happy to speak with you.
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