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Will the Carillion crisis mean a re-think in public procurement?

Thursday 18th January 2018

There’s something about the Carillion crisis that doesn’t seem to add up. The fact that the company has failed confirms the view that there’s no firm too big to go bust. But lift the lid on all the various machinations, it would seem that was precisely why it managed to stay afloat for as long as it did. Was there the underlying assumption by the company itself, the banks and the suppliers, that ultimately the government would not allow failure to happen?

That was certainly the assumption of one small supplier, Flora Tec, now looking at losses to the tune of £800,000. Despite their concern over the financial stability of Carillion after the profit warnings were announced, the fact that the government was still awarding large public contracts, gave them the reassurance they were looking for. Since Monday’s news, they’ve had to let 10 staff go. Having already put up with Carillion’s 120 days payment terms, it’s likely that many other smaller suppliers are now faced with similar problems and worse.

carillionWith 450 public contracts including flagship HS2, and with 20,000 UK employees, shock waves from the firms collapse are likely to spin out in many directions. So how did it happen? It seems to have come about as a result of a perfect storm of mismanagement, bad luck and arrogance. Failures on just four major contracts seems to have been enough to push the company over the cliff. The new hospital in Liverpool, the by-pass in Aberdeen, The Midland Metropolitan hospital and the Qatar World Cup project each ran into problems, causing delays and losses. It would seem that some were foreseeable, such as the possibility of bad weather in Scotland. Combine that with the tough competition for these contracts and aggressive negotiation on price; profit margins were squeezed tight. Great for the taxpayer, but not if that comes at the cost of a huge injection of risk into some of the core infrastructure of the state – schools, hospitals, roads etc.

So why would a company put forward a proposal where the margins are so small? Well, perhaps it's partly because some of the big public contracts come with a large helping of prestige, but it could also be that under the terms of the public private partnerships, the winning bidder in incentivised by large upfront payments. These funds are then used for existing and future projects, making the whole system unstable and vulnerable to a trigger event.

But the company’s fragility was not a surprise to some, with investors short selling (betting on the company’s failure) over the last 5 years. In fact investors, including leading Leave campaigner, Sir Ian Marshall’s company Marshall Wace, have made over £200m from the downfall. And in what appears to be a particularly cynical move, an investigation by the Daily Mail uncovered that just months before issuing the final profit warning, policy changes were made to protect bosses bonuses - something the Head of Corporate Governance at the IoD calls “highly inappropriate" and caused Cabinet Office Minister, David Lidington to add that the Official Receiver has “not only the power to investigate, he has the power to impose severe penalties”

Which begs the question that if the instability of the company was so evident, why did the government continue to award 8 contracts since July’s profit warning? Some commentators have said that pulling the plug at that stage would have hastened the company’s demise, others that it was based on a series of assumptions – that simply add up to the fact that a 200 year old firm with public-private contracts worth £17 billion was here for the long term, regardless. This, despite the fact that at the point of liquidation on Monday, the company had just £29m in cash.

But, some of the company’s debts were not that easy to see. In 2012, the company started an early payment scheme where their suppliers could take their invoices to a number of banks, including RBS and be paid early for a fee. So the debt was transferred from Carillion owing suppliers, to Carillion owing the banks. This debt was buried deep within financial statements as “other” debt totalling £760.5m.

However, it seems that even as recently as Sunday, the Directors thought that it would be possible to save the company. But a tightening of financing terms by RBS just 3 days before the company’s collapse, with more than £22bn of financial liabilities, seems to have been the final straw. Last ditch attempts at obtaining more finance from other banks including Santander and Lloyds also failed.

Carillion’s collapse has shone a light on the nature of public sector procurement and public finance initiatives and the role of some of the major outsourcing contractors. It also highlights once again the various possible conflicts of interest of the big four auditors. In the meantime, we'll wait to see whether there'll be a re-think in the way public procurement operates, or whether when the dust settles, it will it be business as usual.

The firm’s auditors, KPMG are to be investigated by the Financial Reporting Council.

Six executives from PWC have been brought in as “Special Managers” to help with the liquidation.

 

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