It’s time for a radical rethink on payment security and procurement, says Rudi Klein – the Carillion business model is bust
In July last year I wrote a letter to the Financial Times in which I said that construction was heading for financial disaster. I explained that the (then) Carillion profit warnings exposed the fragility of the finances of the top UK contractors.
That disaster has now occurred, with thousands of SMEs fighting for their business lives. The human cost of this is massive, let alone the costs to local communities in which the affected SMEs reside. Once certain public sector clients had decided to appoint Carillion after the profit warnings, some supply chain firms had assumed it was safe to get “into bed” with the company.
Carillion, like many of our largest contractors, was a finance company – not a construction company. Its business model was light on assets but heavy on manipulating its supply chain’s cash flow. More details of the extent of that abuse will, no doubt, emerge over time. As a business it was incompetent in the extreme.
It was extracting retentions from its supply chains when its clients weren’t requiring retentions from it […] carillion acted as a bully and an extortionist
Five years ago it announced that it couldn’t pay its supply chains. So, it introduced its supply chain finance initiative (or reverse factoring) following David Cameron’s announcement that his government was promoting this initiative. Carillion doubled its payment times to 120 days and then invited its supply chain firms to pay a fee to banks to get paid earlier. Firms are now complaining that, in spite of having paid the fee, the facility is closed and they cannot access their cash from the bank.
This supply chain finance arrangement presented a great opportunity for Carillion to counter project bank accounts (PBAs) by saying that it was already helping SMEs. In fact it refused to bid for Crossrail projects when it became clear that PBAs were to be put in place.
It was extracting retentions from its supply chains when its clients weren’t requiring retentions from it. As far as its treatment of its supply chains was concerned Carillion acted as a bully and an extortionist. And all this was ignored by clients – both in the public and private sector – which appointed this middleman to carry out large-scale contracts when they were technically insolvent (their assets were dwarfed by their liabilities).
Where do we go to now? We have to tighten up on payment security. If we had had in place now the three measures mentioned below, the losses would have been significantly less:
- The government must now support the private member’s bill known as the Aldous bill, which proposes legislation to ring-fence cash retentions – its full name is the Construction (Retention Deposit Schemes) Bill.
- There must be added to the Construction Act a requirement that PBAs are applied to all projects over £1m (the state of Queensland in Australia has already legislated to do this). PwC has confirmed that it will respect the trust status of PBAs where they exist on Carillion projects.
- The government must now introduce a yellow/red card scheme so that those companies that do not pay within 30 days are warned that they face exclusion from public sector contracts for two to three years (as is the case in Northern Ireland).
We must now consider how we can amend the Construction Act to tighten up the provisions. Carillion would have been issuing pay less notices on the 119th day after the due date (the day before the final date for payment, as is common practice among main contractors). We need to legislate that pay less notices must be issued no less than 14 days after the due date. Firms should not be left wondering how much they are going to end up with. Furthermore, we should take the opportunity to abolish pay-when-paid arrangements.
The practice of letting out public sector works to large undercapitalised companies on lowest-price lump-sum contracts must cease
The practice of letting out public sector works to large undercapitalised companies on lowest-price lump-sum contracts must cease. Many of Carillion’s services and FM contracts could have been broken up into smaller lots and given to SMEs.
In fact we must take a radically different approach to procuring and delivering major infrastructure and construction works. Government clients now need to adopt modern forms of procurement, such as alliancing supported by integrated project insurance (IPI). Reading University will shortly produce a report on the savings achieved (through reducing process waste) on the first IPI project at Dudley College in the West Midlands.
On the Dudley College project the delivery team worked closely together to deliver against the college’s success criteria. The three insurers required a robust approach to management of financial and technical risk. They, then, insured the cost plan. The whole set-up reflected a “no blame” approach by which the focus was on resolving problems as they emerged rather than chasing possible claims.
Carillion is bust. Its business model is bust. We can’t allow the industry to go bust.
There’s no going back. We must now prepare for radical changes in procurement and delivery and effective improvements in payment security.
Rudi Klein is a barrister and chief executive of the Specialist Engineering Contractors’ Group