Liquidation can send you down the drain

By Adam Bernstein, Monday 19 February 2018

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The failure of Carillion, the UK’s second largest construction business, followed the loss of vast sums of money on big contracts and debts totalling more than £1.5bn, including a huge pension shortfall – officially reported as £587m but which an analysis for Sky News reckons is nearer £2.6bn – and £900m owed to the banks.

plughole

The liquidation is already having a significant impact on a number of stakeholders, including employees, suppliers and sub-contractors. And it appears that the only winners over the last 10 years are allegedly the former directors as well as the big four accountancy firms, which earned £72m in fees and who were described by MPs as “feasting on what was soon to become a carcass”. So far 6,668 jobs have been saved, 1,000 lost and another 11,800 staffers are still waiting on their fate. 

Mistakes at the top

Charles Jarrold, chief executive of the BPIF, considers the failure the result of “another large company not understanding the cost and value of what it was being asked to do, and underpricing its bids”. He says it damages companies who do understand that value, but can’t win work at viable prices.

Mike Cherry, national chairman of the Federation of Small Businesses agrees: “Sadly, poor payment practices are all too common among some big corporates. Perhaps if they weren’t it would be easier to spot the warning signs of a huge company in financial trouble.”

Nevertheless, he’s of the view that “Carillion’s small business suppliers [should be] paid what they are owed, or some could themselves be put in jeopardy, putting even more jobs at risk.”

Ian Cass, managing director of the Forum of Private Business, is very disappointed that the government didn’t act earlier. “Many in the City were shorting Carillion stock as far back as spring 2016,” he says. “If they could see the issues why couldn’t the government? This also highlights on a grand scale what late payment can mean for a business; the Qatar foundation owed Carillion over £200m and the company had £1.7bn owed to it in 2016 with a large proportion of this having not been invoiced.”

For the moment Jarrold sees the impact on print as being minimal “as most of Carillion’s activities were in sectors that don’t generate a lot of print... Those companies that have been affected appear, at this stage, to be okay .”

Even so, as Cass points out, “part of the tragedy is that a lot of the work will have been carried out by smaller suppliers and they will have received a fraction of the original government payment as Carillion and others will have taken their percentage before handing the work down the line.”

But for those who have been hit, Carillion’s liquidator, PwC is offering advice at www.pwc.co.uk while the government is doing the same on its gov.uk website. In essence, PwC asked suppliers, employees and other stakeholders to continue ‘as normal’, assuring them that they will be paid for any work or supplies made from 15 January.

The problem, however, is, as Ed Husband, a partner at law firm VWV, notes, the period before Carillion’s liquidation was announced.

The process of liquidation

Liquidation (also known as winding up) is unlike other procedures that seek to allow a business to survive. Here the assets of company are realised and distributed to creditors to pay off debts they are owed in the order of priority as set out in the Insolvency Act 1986.

Husband says: “In a compulsory liquidation a court will order the procedure, often following a petition presented by a creditor, although the company itself or its directors may also present a petition.” In Carillion’s case, it appears that the company started the compulsory liquidation process once it became clear that negotiations with the banks, Pensions Regulator and the government had failed.

It is relatively unusual for a group of Carillion’s scale to go straight into liquidation rather than administration. “It seems likely,” says Husband, “that the liquidation is primarily due to the strategic significance of Carillion and the need for government intervention in the wide range of public projects with which it is involved. It may also reflect the limited likelihood of the businesses being successfully rescued.”

The problem that Husband notes is that those at the bottom are finding that unfortunately, the ordinary trade creditor is invariably ranked as an unsecured creditor and so is last in line for any pay-out. This only heightens the need for prompt action.

Carillion companies affected

From a practical and legal standpoint, it is important to check whether a contract is with one of the 18 Carillion companies that has entered liquidation. These firms are listed on the PwC website.

The sheer scale of this liquidation is sending shockwaves among the private and public sectors alike and Husband reckons “that the ripple effect of Carillion’s failure is likely to have a significant impact on the many businesses and individuals connected to it. Not just in construction, but among others providing goods and services to Carillion and its subsidiaries.”

With contracts at risk businesses face an uncertain and potentially catastrophic future. It’s for this reason that Husband cautions directors of companies facing loss “to understand their personal duties (and potential liabilities) in the face of their company’s resulting financial difficulties.”

Taking action

For those left in the unenviable position of being owed substantial debts, there’s no good news – they are likely to receive very little or nothing on top of the loss of future revenue. The problem is compounded because options normally available to them against a solvent company are unlikely to be appropriate or possible.

Even secured creditors are facing losses says Husband. “While compulsory liquidation does not prevent a secured creditor enforcing its security, existing legal proceedings are suspended, and a creditor cannot begin new legal proceedings against the company unless it has permission to do so from the court.”

But while options are limited there are steps that can be taken.

The first Husband points to is ‘set-off’ where a sub-contractor or supplier who owes money to the insolvent company may be able to offset that debt against money it is owed.

Going forward, it’s important to review the terms of contracts carefully, and regularly. From experience Husband has seen changes to insolvency legislation and processes mean that many older contracts are often simply not fit for purpose. 

He says: “As part of a review, a well drafted contract will include provisions governing what is to happen on the insolvency of either party; it should, for example, clearly state whether the contract is to terminate automatically or only at the instigation of the other party.” Just downing tools could be a breach of contract.

Printers maybe able to seek solace in a ‘retention of title’ clause. A properly drafted clause should allow the unpaid supplier to retain ownership of and reclaim possession of its goods. The problem for the sector is that it’s not easy to reuse what’s been bespoke printed.

Naturally there is a limit to what can be achieved in documentation, which makes a proper credit control system critical. Where the sub-contractor or supplier has concerns Husband advises considering reducing the period and/or amount of credit allowed and obtaining alternative forms of security and taking out credit insurance. (A BBC report reckons that at the time of writing some £31m is being paid out to firms with credit insurance as a result of the Carillion failure.)

It’s interesting to note that Cass has heard of his members struggling as they deal with non-payment by Carillion on their cashflow. Not that he reckons that Carillion was doing a great job of managing its own finances: “Carillion themselves were being paid by customers in 112 days in 2016, the figure was nearer 69 days in 2011, which highlights the on-going issue with late payment in all businesses.”

Jarrold says printers should cover off the basics as the first step to self-preservation: “Do your credit checks, and if in doubt, get directors’ guarantees while considering getting elements paid up front, especially paper and materials costs.” He also takes pains to remind the sector that extending longer payment periods isn’t just about cashflow, it’s also about risk – “several months worth of work unpaid can represent a considerable financial sum”.

Cass offers more advice. He says firms should keep a balanced portfolio of customers; if you have a single large customer that carries risk. He also advises firms to manage cashflow proactively – “keeping in regular contact with customers’ finance departments to make sure you have a good relationship. Further, if your larger customer has an early payment facility take a look at it, there may be a small fee, but this may be offset through getting the money into your business account.”

The last option to consider is whether any agreements with a Carillion company affected by liquidation can be transferred to another contractor who is willing to step in. From a practical employment perspective, Jarrold’s hoping that employees will transfer (under TUPE) to new organisations – which is exactly how (so far) those 6,668 jobs have been saved.

Take early advice

Businesses affected by Carillion need to take rapid action to prepare for the worst and minimise the fallout. This means getting advice to review contracts and options available in the event all or a significant part of their revenue dries up, or they find themselves with a large non-collectable debt. “A ‘wait and see’ approach,” says Husband, “will likely mean that a business will be forced into a much more difficult position at short notice with fewer and more limited options.”

Lessons to be learned

Cherry thinks there are lessons to be learned about the concentration of public contracts in the hands of a few very big businesses. He wants public procurement to be much more small-business friendly, “in which it is easier for small firms to navigate the system… [as] providing small businesses and the self-employed with more opportunities to secure public contracts will mean less risk for the taxpayer”.

The last word goes to the BPIF. It is well aware of the damage caused by the culture of delayed payments and extended credit. Says Jarrold: “The government is a major contractor and is in a position to require that large organisations don’t abuse their power by implementing extended credit periods. We’d like to see the government work to simplify its tendering processes to make them less onerous and more worthwhile for SMEs to participate in.” 

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