Carillion PLC, one the UK’s largest support services contractors, with interests in everything from construction work on the HS2 rail project to running prisons, hospitals and schools, went into compulsory liquidation on Monday, with debts of around £1.5bn.

After a meeting with its lenders, Carillion announced it would begin a formal insolvency procedure. Its low-margin contracts were insufficient to secure further lending to save the business. It is estimated that the value of these contracts will not be enough to pay bank creditors, let alone subcontractors.

The Court has appointed an Official Receiver as Liquidator and PwC partners have been appointed as Special Managers. The government will support the Official Receiver with the funding required to ensure the continuity of public services whilst securing the best outcome for creditors.

Domino Effect

Carillion employed 20,000 staff and used a wide range of small companies as subcontractors. The company’s demise is expected to have a domino effect that will be felt throughout the supply chain as it is estimated that between 25,000 and 30,000 businesses are owed money by the company, according to trade body Build UK.

Mike Cherry, Head of The Federation of Small Businesses (FSB), said thousands of jobs and livelihoods were now at risk because these firms would be at the back of the queue for payment.

“These unpaid bills may well go back several months,” he continued. “I wrote to Carillion back in July last year to express concern after hearing from FSB members that the company was making small suppliers wait 120 days to be paid.”

All Carillion employees, agents and subcontractors are being asked by the government to continue to work as normal, unless told otherwise and that they will be paid for work during the liquidation.

How did Carillion get into Trouble?

Carillion expanded quickly via a number of acquisitions, racked up a lot of debt. Additionally, its business’ revenue model has been criticised for being unsustainable. The business model for the support service industry entails bidding for contracts and once a contract has been won, borrowing upfront for the setup costs of the contract. The provider is then repaid by the customer over the lifetime of the contract, which could span between 20 and 30 years. Therein lies the problem because the company has spent a large amount of money upfront, which will only be recouped over a long period of time.

Carillion had amassed a debt pile through M&A and along with its unsustainable business model got into trouble quickly, with a series of shock profit warnings since July 2017. The company was desperate to win contracts and its low-margin bids were unable to cover its increasing liabilities, such as its employee pension pot.

Procurement rules state that the government must exclude any outsourcer, such as Carillion, with an “abnormally low” bid. As one lawyer told the Financial Times: “Carillion has tendered at very low margins, possibly unsustainably low, in order to win these huge volumes of work.”

In spite of growing concerns about Carillion’s financial position, the government continued to award the company lucrative contracts. Its collapse raises a question mark over the industry’s revenue model as companies are encouraged by the government to bid low for contracts and then can go bust when revenues don’t meet expectations. Additionally, Carillion’s track record of irresponsibly low bidding may also be an indication that the rules themselves are ineffective or that public sector clients lack the confidence or expertise to enforce the regulations.

Government response

On Monday, David Lidington, Minister for the Cabinet Office, published a formal statement where he states that the government will continue to deliver all public sector services following the insolvency of Carillion. Lidington said that it is regrettable that Carillion has not been able to find suitable financing options with its lenders, but taxpayers cannot be expected to bail out a private sector company.

He added that since profit warnings were first issued in July, the government has been closely monitoring the situation and has been in discussions with Carillion while it sought to refinance its business.

He commented: “We remained hopeful that a solution could be found while putting robust contingency plans in place to prepare for every eventuality. It is, of course, disappointing that Carillion has become insolvent, but our primary responsibility has always been to keep our essential public services running safely.”

“For clarity – All employees should keep coming to work, you will continue to get paid. Staff who are engaged on public sector contracts still have important work to do.” However, subcontractors working on private sector deals will only have two days of government support, he subsequently warned.

Executive pay Scandal

The collapse also sees mounting criticism of director pay prior to Carillion’s insolvency. Richard Howson, who was Chief Executive until last year when Carillion issued the first of three profit warnings, managed to secure a controversial deal where he is paid for 12 months after his departure from the company.

Lidington told the Commons on Monday that the Official Receiver had the power to impose penalties if it uncovered any misconduct.

Howson also increased dividends to investors at the same time as the hole in the pension pot grew. Thousands of employees who paid into Carillion’s retirement schemes will have their current and future pension benefits cut. Sir Steve Webb, former Pensions Minister, told the Financial Times: “Is this really acceptable alongside a pension fund deficit over half a billion pounds?”

Frank Field, Chair of the Work and Pensions Select Committee of MPs, commented: “Over a year ago, we called for the Pensions Regulator to have mandatory clearance powers for corporate activities (…) that put pension schemes at risk, and powers to impose truly deterrent fines that would focus boardroom minds.”

He added: “If the government had acted then, the brakes might have been put on Carillion’s massive ramping up of debt and it would never have fallen into this sorry crisis.”