Carillion collapse: a warning for the Australian construction industry

Carillion (the UK’s second largest construction company) went into liquidation in mid January 2018, with reported debts of approximately £1.5bn.

In the UK, this has caused significant and ongoing angst within the UK Government and the construction industry more broadly about how such an important and large player could “go under”, and how to untangle the mess left behind. For example, there are already significant job losses and pension concerns at Carillion, an estimated 30,000 subcontractors owed money, and core Government projects (such as the new £355 million Liverpool Hospital) suffering delays and uncertainty.

The analysis of the cause of the collapse will continue to evolve (with a UK Parliamentary inquiry having commenced on 6 February 2018). Some commentators have noted major projects encountering difficulties and increasing levels of debt as playing a part.  Whatever the ultimate combination of causes, it begs the question: could the same thing happen here in Australia?

As lawyers, one of our roles is to ensure that our clients are well positioned to avoid, mitigate and if necessary respond to, any “Carillion-style” failures.

This Alert looks at some of the issues which we discuss with our construction and infrastructure clients in this context.  It also acts as a timely reminder of the need to identify, allocate and price risk correctly at the outset of a project, and carefully administer contracts throughout the life of a project.

Getting procurement “right”

Choosing the right contract model

There are a range of drivers when choosing the optimal contract model.  These include the level of flexibility and/or control required by a principal, the level of contractor innovation desired, and the manner in which a project is to be funded.

There has been some UK commentary suggesting that the Carillion collapse means the PPP model needs to be re-examined, particularly in the context where the State is left with little option but to step-in and continue providing essential services (at least in the short term).  Whilst this may be an immediate or knee-jerk response against PPPs, it does raise the valid point of the need to ensure that the right contract model is chosen (whether it be PPP or otherwise).

Identify and manage risks 

Getting risk allocation wrong, can have major consequences for the outcomes of projects, in terms of budget/profitability, completion time, quality and other outcomes.  Identifying and managing risks at the outset of a major project is critical.  Often, there is an attempt at total “risk-transfer” (and in some cases, this can be appropriate) however it can miss opportunities to avoid risks altogether – for example, through early works / ECI arrangements or clever contract packaging – or share risks in a cost-effective and sophisticated manner.    In the context of thin profit margins on significant projects (which has been noted in respect of Carillion), this issue becomes even more critical, and emphasises the need to undertake proper financial due diligence during the procurement phase.

Pricing risk

Related to the need to appropriately manage risks, a common pitfall can be selecting (or bidding) the “cheapest” price, rather than the most “well-priced”.  In our experience, whilst a significantly cheaper or under-priced bid may appear attractive to a principal at the outset (and secure a role for a contractor), it can generate a more adversarial relationship during delivery and compromised outcomes for one or both parties, if the price is artificially or unrealistically low.  In this context, there is a need for all participants to engage in realistic discussions on pricing at the outset, particularly in an industry where major participants want long-term sustainable relationships.

Have tools ready/available to manage when it goes “wrong”

Early warning signs

Whilst not definitive, there are a number of early warning signs which may indicate that a company has an increased insolvency risk. Some of the common signs include: slower timeframes for payments to suppliers and/or subcontractors; poor or slow documentation of variations and/or progress claims; an increased number of disputes over progress claims and/or variations; and increased delays in the contract deliverables for no obvious reason.

In the Carillion context, Dr Chris Higson from the London Business School noted that Carillion moved to 120 day payment terms in 2012, suggesting a use of bank borrowing to bridge the gap in paying creditors, and that by 2016, Carillion was taking even longer to pay its suppliers.

Where these symptoms start to arise, there is a need to review what measures are in place to ensure that if the company does become insolvent, the loss to the affected party is minimised as much as possible. A timely review of the security position and rights in the event of an insolvency could avoid significant adverse consequences.

Security

Most contracts will include security for a contractor’s or subcontractor’s performance (or for loss and damage sustained due to non performance) by way of either a Bank Guarantee or retention monies. Ensure that you are aware of the contractual rights giving rise to the right to claim those monies and that you have access to the relevant Bank Guarantees and are aware of their terms (for example, insolvency may not necessarily trigger a right to recourse). In the event of insolvency, this will be the first obvious way to mitigate against any immediate financial loss.

It is also important to consider whether any equipment, materials or tools have been hired or leased for the life of the project. If there are any bailment or leasing arrangements in place with the company who is at risk of insolvency, there are significant implications if that security interest is not adequately protected by appropriate registrations under the Personal Property Securities Act 2009 (Cth). An ineffective registration results in the security interest vesting in the company who has become insolvent at your cost. This cost can be considerable, particularly where the equipment or goods have a significant value.

Step-in rights

Many contracts will provide step-in rights in the event of insolvency to allow a principal/contractor to arrange for another company to complete that work. It is important to prepare and review the contractual provisions to ensure that the rights are sufficient to allow what is required to complete the project, to make a decision as to whether it is preferable to exercise those step-in rights or not and the likely cost & time implications to the project. In some instances, it may be preferable to work with the insolvency practitioner in an attempt to complete the project rather than exercising the step-in rights.

Finally, the upcoming insolvency law reforms with respect to ‘ipso facto’ clauses (i.e.- a clause giving rights to terminate arising from the fact that the company has become insolvent), will provide a stay on the enforcement of those clauses for contracts entered into after 1 July 2018. This means that it is important that the default provisions giving rise to step-in rights in future contracts adequately consider and address that issue.

Thinking about these issues across the whole project lifecycle, and correctly structuring project documentation at the outset, is without doubt one of the core factors in determining the success or otherwise of a project and, ultimately, a business.  Our role is to work with principals, contractors, consultants and other industry participants to navigate these issues during the entire project lifecycle, from project inception and procurement, right through delivery, completion and operation.

This article was written by Simon Walsh, Partner and Adam Young, Partner.