Carillion lessons to be learnt
It has only been a few weeks since Carillion went into liquidation and suddenly one of the biggest construction and service companies in the country is gone. In this article, we give some practical advice on how best to protect yourself if you are in contract with a company, or about to enter into contract with a company, that might have hidden financial difficulties.
Let’s be honest for a moment corporate insolvencies and bankruptcies happen and most of the time they come as a surprise. Carillion was not really a surprise as it had been flagged up for months before it happened. Equally, it is not so rife that you can go through your entire business career barely being affected by an insolvency. In the construction and real estate industry we are all too often affected by insolvency. One of the main drivers of insolvencies is the payment mechanisms of the construction industry where the contractor, primarily the sub-contractors on behalf of the contractors, pay up front for the work and the Employer pays anything up to 60 days behind the time work was carried out.
The first thing to do is do your due diligence before you enter into contract, and by that we do not mean just having a credit check carried out, as these can be based on data that is years old, it means asking smart questions of your contractor or employer to find out how well funded they are, check that they have all the most up to date insurances and whether there is a well-funded parent company. Do not rely on market capitalisation, look what happened to Carillion.
The second thing to do is to look at what is insolvency. Section 113 of the Housing Grants Construction and Regeneration Act 1996 defines insolvency as follows:
113 Prohibition of conditional payment provisions.
(2) For the purposes of this section a company becomes insolvent—
(a) on the making of an administration order against it under Part II of the Insolvency Act 1986,
(b) on the appointment of an administrative receiver or a receiver or manager of its property under Chapter I of Part III of that Act, or the appointment of a receiver under Chapter II of that Part,
(c) on the passing of a resolution for voluntary winding-up without a declaration of solvency under section 89 of that Act, or
(d)on the making of a winding-up order under Part IV or V of that Act.
(3) For the purposes of this section a partnership becomes insolvent—
(a)on the making of a winding-up order against it under any provision of the Insolvency Act 1986 as applied by an order under section 420 of that Act, or
(b)when sequestration is awarded on the estate of the partnership under section 12 of the Bankruptcy (Scotland) Act 1985 or the partnership grants a trust deed for its creditors.
A version of this definition appears throughout standard form construction contracts used in the UK and it is only when one of these events that, if you use standard form contracts, must happen for you to terminate. The problem is that this can be too late and the damage will have been done to your project by then.
There are ways around such problems with termination at will clauses, clauses inserted into a contract which entitle the Employer, it never work the other way around, to end the contract by the issue of a letter and not to owe the contractor any money for the termination.
Given the recent events with Carillion, other options for funding works during a project are being discussed. One option being pushed is the use of project bank accounts (PBA’s). They have long existed, however, now with the SES pushing for them they are coming into focus. PBA’s were first introduced in 2007 by the government and have funded many billions of pounds of work. The great advantage of such arrangements is that the money is in a dedicated account from which all members of the team can draw a payment once it has been certified. This has the effect of greatly speeding up the payment and therefore the flow of cash through the project. It would not, however, protect against the kind of situation we had with Carillion, although it would have protected the subcontractors employed by Carillion.
The reality is that there is no substitute for due diligence when entering into a contract, the measures against which a decision is made should not be solely financial as in the price of the works, but, also the ability of the contractor to survive any financial pressure over the term of the works.
If you are about to start a new project to speak to one of our team who will be happy to advise you on your options.
This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 0207 404 0606 and ask to speak to your usual Goodman Derrick contact.