Stephen Wainwright, Partner, Poppleton & Appleby
In the wake of the recent Carillion collapse, Insolvency Practitioners, Poppleton & Appleby, understand that many sub-contractors may be feeling uneasy about the wider spread implications. Main contractors may not be paying for work that is being done and some may even become insolvent themselves.
Partner Stephen Wainwright talks to us about what can be learnt from recent events and what to be looking out for, to avoid such situations.
Tell us about the recent collapse of Carillion?
Carillion the second largest UK construction company went into liquidation on 15th January 2018 when talks with its lenders and the Government failed to reach a deal with debts estimated at circa £1.5b.
The company's financial issues were widely covered in the press and its demise was a long drawn out process. In the 12 months leading up to the company failure, there were 3 profit warnings and in November 17, one of the warnings referred to a breach in its banking covenants.
It is surprising that a company with a reported 450 global contracts could fail because 3 or 4 contracts proved to be unprofitable.
The company relied heavily on large public service contracts which very often were less profitable and some contracts under-performed resulting in a debt burden of £900m.
Following 3 profit warnings, its banks were naturally averse to increasing their exposure. As a result, and presumably in their minds to relieve themselves of ongoing cash flow problems, they successfully tendered for well documented public finance contracts with lowprofit margins. I am sure people in the civil service and Government must be asked why a company that had made 3 profit warnings, the first in July 2017, was subsequently awarded such large contracts.
Carillion itself relied heavily on major public contracts which, in some instances, granted upfront finance. It appears that Carillion may have used these funds in dealing with its general ongoing financial situation rather than to fund the specific contract.
This may have worked to some degree but clearly without sufficient profit in contracts, the costs of delays and overruns typically encountered put the company into loss making territory.
How could this have been avoided?
I would have expected the company to have entered into administration, which is a process that aims to help a company restructure whilst avoiding a formal winding down and liquidation of the company. However, that would have required sufficient working capital to enable an Administrator to continue to trade whilst a buyer was sought, which the company simply didn't have.
When the board of directors realised that there was going to be a major cash flow difficulty then they could have sought the advices of a turnover/restructuring specialist.
Even the most astute board can miss the early signs of distress. Naturally over the years, I have seen many crisis situations and naturally I have seen my share of "boiled frogs" – comparing companies in crisis with the metaphorical frog that does not notice the water it is in warming up until it is too late.
Most directors and managers often work under a set of parameters that no longer apply in a financial crisis, effectively allowing inertia to carry them along. Often the board will take advantage of cheap and widely available finance which in the short-term plasters over the poor performance of the company whilst believing that the adverse conditions are a temporary blip and that there will be a return to normality. If the underlying problems within the business are not resolved, then the money will ultimately run out and this process will repeat even if further monies are introduced. I've seen this countless times during my career as a business turnaround and Insolvency Practitioner.
In these circumstances, it is useful to utilise outside turnaround specialists to look at the business structure without blinkers or preconceived knowledge of the business.
In the case of Carillion, a turnaround specialist would have worked in-house with the board of directors and senior management and implemented a turnaround plan. At that stage, the specialist would have formulated a business plan and spoken with lenders and other principal stakeholders.
What should people in the construction industry, specifically, be looking out for?
Before being engaged with a project, you need to ensure that your client is financially sound. It may be helpful to ask the following questions:
How healthy are their financial statements?
They should be able to show you the last recent audited accounts as well as recent management accounts. There are a number of credit agencies who can provide financial accounts as well as recent data regarding possible summonses, etc. and provide a credit score. The costs are not considerable but could be very useful when first starting out with a client you have never worked with before. If a company refuses to provide financial information, I would think twice before working for them.
What is their annual turnover in relation to the value of the project?
If your project is £500,000 and the contractor turns over £5m a year, they may have problems in financing a contract and therefore there may be delays which ultimately could be caught by you.
Following the demise of Carillion and other well-known entities, it is clear that no company is too big to fail and therefore, doing your homework in carrying out due diligence before engaging with companies large or small, should be done in each and every case.
Most businesses have a credit rating and it may be surprising to know that only 15% have a low probability of failure.
Do they pay on time?
A very good barometer is to check if the company that wishes to engage with you pays their suppliers. If they are a plc, there are websites you can google who will give you this information.
How long have they been in business?
This may be an obvious one but rarely do people check how long their clients has been trading for. Ideally, you would want to work with a company that has been trading for at least 5 years and which has consistently grown with their P&L account increasing year by year.
It is important to know what other sub-contractors will be used on your project and although it may be laborious, it is certainly worthwhile doing some due diligence on them as they too may have issues which would impact on your ability to complete works and ultimately receive payment.
If you are entering into a large contract and have any concerns, I would strongly suggest a face to face meeting with the directors and, if needs be, your accountant or FD who can try and ascertain the company's financial state and well-being.
A framework agreement is for long term projects usually for large clients. If contractors have these in place, it may be worth considering liaising with their clients to get an understanding of their past performance.
Partner, Poppleton & Appleby
Licensed Insolvency Practitioner and Business Recovery Specialist