Construction in the Wake of Carillion’s Collapse
The start of this year saw the UK construction industry rocked with one of the biggest stories in years: the collapse of Carillion. Lucy Ingham looks at how the collapse may affect the sector, and what will need to change to prevent the same problem reoccurring in the future
Image courtesy of Elliott Brown
Once every few years, something happens that was thought to be impossible, causing shockwaves across entire industries and forcing a reassessment of even the most basic practices in a sector. On 15 January 2018, this happened to the construction industry, when “too big to fail” Carillion, a multinational facilities management and construction services company with over 40,000 employees, went into liquidation.
The fallout from this incident was significant, and the true effects are still unfolding, however what is clear is that the collapse put smaller suppliers at significant risk.
“Carillion’s liquidation is terrible news for all those who work for the company and it will have serious knock-on effects for the many smaller firms in its supply chain, some of which will be in serious financial danger as a result of Carillion’s demise,” said Brian Berry, chief executive of the Federation of Master Builders, immediately after the news broke.
However, the industry major’s liquidation may have even more of an impact than the potential bankruptcy of a slew of small firms, calling into question the entire process through which the UK government secures contracts.
Threats to subcontractors following Carillion’s collapse
“ What we want is the contractors to be seeking professional advice, so they actually use the mechanisms in the contract how they should be using it. ”
The very nature of Carillion’s work involved the use of a multitude of subcontractors, many of which are small firms local to the projects in question. For some, and particularly in cases where the projects are quickly taken over by other firms, the liquidation may pose no more than an inconvenience. However, for others, it could pose very significant risk to entire businesses.
“The impact will be catastrophic on those who are maybe already 120, 240 days outside the contractual time they should be receiving payment,” says Alexander Wood, partner in the insolvency and business recovery team at law firm Coffin Mew.
“If they're small enough, and Carillion is central enough as a work provider to them that they don't have any other means of paying their staff or overheads on their premises, that will be catastrophic: they can't find any other way of overcoming that cash shortfall.”
“It could put subcontractors out of business,” adds Mark James, a partner in dispute resolution at Coffin Mew. “What you've got is specialist subcontractors who were appointed on Carillion projects and there's going to be issues which they're immediately going to have to tackle.
“What we want is the contractors to be seeking professional advice, so they actually use the mechanisms in the contract how they should be using it – depending on their own individual circumstances – because otherwise it’s going to create potential cash flow problems that will shudder through the whole of the subcontractors on the projects.”
Safety in government: the dangers of putting all the work in one basket
“ As hard a lesson as it is, if you build a business model surrounding one or two work providers, that in the long term is a business model that you may regret. ”
It’s clear that the companies that are most at risk as the ones where a significant amount of their work is through Carillion-led contracts, which begs the question: shouldn’t such companies have been more wary of relying on a single source for most of their work?
“It's a typical putting all your eggs in one basket, or not, scenario really. And the problem they've got is they do put all their eggs in one basket, what happens like in this case it's one big project and the employer goes bust, they've got problems with that then because they haven't got any projects to fall back on to keep their cash flow going,” says James.
Of course, the issue here is that these are contracts that combine the government – generally considered a work provider that can be relied upon above others to pay its bills – with, as Wood puts it, “a massive institution like Carillion in the middle: too big to fail”.
“As hard a lesson as it is, if you build a business model surrounding one or two work providers – even if you get given implicit governmental promises that work is going to be given to you – that in the long term is a business model that you may regret,” he adds. “You have to diversify where you're getting your work from in order to be sure your business model can carry on in the long-term future.”
Essentially, it’s difficult to criticise contractors for relying on Carillion-led work, given the apparently safe appearance of the projects involved.
“Unfortunately there are a lot of subcontractors who have got into this business based on promises they can't rely on, but implicit promises from the government that if you sign up to these schemes and contract with Carillion, this is going to be very good work for you for the next ten years. And that has proven not to be the case,” says Wood.
“Certainly if you're a small subcontractor you are likely to be thinking 'this is a great opportunity for us if we can win this contract, which is government-led',” adds James.
However, while the collapse of Carillion may produce a change in attitude to these types of projects, it may not produce the wholesale rejection that some may expect.
“I think it will still be an attractive proposition to take on some work under a government-led contract,” says James.
“I think it’s a wake-up call,” adds Wood. “But one of the problems with this public/private setup they have in the construction/development industry is that all the contracts ultimately flow from the government, which you see as being a source that will never go away and will always be good for its money.
“But if in between you interpose entities that can suddenly fall away like Carillion, in the financial sense, then there is a risk there that you may not have thought about at the start, because you see it as always being one monolithic supplier of work.”
Image courtesy of Ron Ellis / Shutterstock.com
Seeing the positives: why some companies may benefit from the collapse of Carillion
“ For those who can, it could actually be an opportunity for them – if they're bold enough – to try and seek better terms. ”
However, while some companies could be utterly destroyed, others – albeit potentially fewer in number – may be able to benefit from the situation.
“For those who can, it could actually be an opportunity for them – if they're bold enough – to try and seek better terms,” muses Wood.
“Because those who are providing services that have to be provided, whether it’s on public contracts or private contracts, those services still need to be provided to the country, to UK plc, and the people either side of them in the contractual scheme also need the business to be done. But if just by absence of Carillion being out highlights how necessary a subcontractor's piece of work is, they can use that.
“When whoever takes on Carillion's role in this comes in and is able to contract with these subcontractors, they can potentially use it to gain better terms for themselves going forwards, and say 'we're not going to have this happen to us again, we're prepared to ride out a cashflow hiatus now, just because its Carillion's fault and not yours, but going forward we're going to have better terms for our advantage, otherwise we're not going to carry on doing this work, which we know you need us to do'.”
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Transforming the tendering process: what needs to change
“ There's got to be something up with a company the size of Carillion winning as much of the work as it did from government-led contracts. ”
For the wider industry, however, the biggest long-term impact may be in changes to the tender process for government work, which has seen considerable criticism in the wake of the collapse.
“I would like to see the government making changes to its tender process, which would give us a fairer tender process, because there's got to be something up with a company the size of Carillion winning as much of the work as it did from government-led contracts,” says James. “That work, I think it should have been dispersed more widely in the construction industry, that's my personal view.”
In particular, Wood and James argue that there needs to be more rigour within the tendering process, and a move away from the approach of simply awarding contracts to the lowest-priced bid.
“I think you might find there will also be a change in the quality of those within the civil service who do the tendering of these contracts, because one of the major criticisms has been that they've allowed tenders to go to the lowest common denominator in terms of pricing without there really being sufficient rigour in terms of whether that pricing mechanism can actually realistically be followed through,” adds Wood.
“And it's led to people putting in a tender value as low as they possibly can just to get the initial work, on at least their tacit recognition that over time costs are going to go much higher than their tender price, but there won't be much anyone can do at that point in time if they want the project to go forward.
“What that means is you end up with business models being put together that don't really fit together very well. If you had a more rigorous tendering process in the first place you might have more honest pricing by the contractors and the subcontractors who line up behind them, and then a more realistic expectation of how much things are going to cost in the long term, but also how the project can be managed from the governmental point of view as well.”
“I'm sure it will come out over the coming months just how much scrutiny was involved in the tender processes when these jobs were awarded to Carillion,” adds James. “It will be quite an interesting disclosure to be had from the government.”