Collapse of Outsourcing Giant Carillion May Have Silver Lining

Collapse of Outsourcing Giant Carillion May Have Silver Lining

by Don Quijones • Sep 15, 2018 • 19 Comments

“Cash retentions” by large companies come under attack in the UK.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

The bankruptcy of UK outsourcing behemoth Carillion in January has left in its wake a trail of financial destruction and mayhem, but it may end up having a positive legacy. More than 200 British MPs (out of a total of 650) have backed a campaign to crack down on construction firms which, like Carillion, routinely pay their suppliers late to spruce up their own balance sheets. The Aldous Bill, named after the MP who is leading the campaign, Peter Aldous, is intended to put an end to this practice.

Late payment of suppliers and subcontractors is a widespread problem in the UK, and many other countries. Perversely, the worst offenders are often large companies that claim to comply with official payment codes.

“It’s a bitter irony that while Carillion were fully signed up to the government’s prompt payment code, they were making their suppliers hang on for 120 days or more to be paid,” said Rachel Reeves, chair of the Business, Energy and Industrial Strategy Committee.

One of the common ways payment is delayed in the UK is through the use of so-called “retentions”. These are monies — often between 5-10% of a contract’s total value — that are held back by contractors until a sub-contractor has completed its job satisfactorily. The cash is held to provide some semblance of protection against late completion and defects arising during the rectification period. However, in practice, it is often withheld to bolster the working capital of the group withholding the cash.

This is a common occurrence in the UK, often with brutal cash-flow effects for smaller firms lower down the supply chain, says Peter Aldous in the preamble to his bill:

“Under standard industry contracts, retentions should be returned within 12 months of the handover of the works in question, but there are regular delays of upwards of three years. According to Government figures, almost £8 billion of cash retentions has remained unpaid over the last three years and, in one case, 12 years. Most of that cash has been provided by SMEs.”

The smaller a company is, the longer it has to wait to receive cash retentions. Tier 1 (i.e. very large) contractors suffer average delays of three months, tier 2 (mid-sized companies), seven months, and tier 3 (the smallest companies), over nine months.

“It seems that the smaller the business is, the harder it is hit,” says Aldous. “The abuse of retentions has a negative knock-on domino effect that cascades through the construction industry. It restricts investment in new equipment and facilities. It prevents firms from taking on more work, and discourages them from employing more people and investing in apprenticeships.”

Some £3 billion of retentions remain outstanding in the UK construction industry at any one time. When Carillion collapsed in January, it owed some £800 million to thousands of sub-contractors, some of which have since fallen into insolvency as a result. Construction News reported that one subcontractor working on a Carillion PFI project was awaiting retention payments of around £200,000, while another firm was owed more than £150,000 on a long-term housing maintenance deal Carillion signed with a government body.

Almost half of construction businesses that have had retentions held in the last three years have experienced non-payment due to upstream insolvency, with the average amount lost per contract being £79,900, according to research carried out by the Building Engineering Services Association. The average cost of taking legal action to recover unpaid retentions in the last three years was £16,300 per contract.

With his proposed legislation, Aldous hopes to remedy these problems. But as he admits, his bill is merely the latest in a long line of litigious attempts to put an end to the abuse of retentions. For example, the Construction Act of 1996 omitted any mention of retentions reform, despite the fact the report on which it was based included a recommendation to place cash retentions in a secure trust fund. That recommendation “remains outstanding,” says Aldous.

If the Aldous bill is passed in October, that oversight may finally be rectified. The bill proposes securing and ring fencing retention money in a deposit system, so that the money can be “released on time, rather than be subject to the current wait of two or more years.” The party to whom the retention is due will still be incentivized to complete on time and remedy any defects, but if the retention holder enters insolvency, the cash retention, held in a Government approved deposit system, would fall outside the insolvency process.

Many other countries already have similar such procedures in place to ring-fence cash retentions and/or provide security for construction payments as a whole, saysAldous:

“In Canada and the United States, a system of charges can be placed on a building or structure by a firm that has not received its payment. Australia and New Zealand have legislated to ring-fence moneys. France has a statutory framework that requires bank guarantees to be used as security for payment in the construction industries.”

For subcontractors in the UK, no such protections against upstream insolvency currently exist. But that could be set to change. If the Aldous Bill passes in the Fall, small suppliers may finally enjoy greater protection from the financial fallout of Carillion-like bankruptcies. If that happens, perhaps something positive may actually be salvaged from the wreck of Carillion’s collapse. By Don Quijones.

Use of this financial instrument has ballooned. No one knows to what extent because there’s no disclosure. But it was a “key contributor” to the sudden collapse of outsourcing giant Carillion. Read…  “Hidden Debt Loophole Could be Widespread”: Fitch

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