Collapse of Outsourcing Giant Carillion May Have Silver Lining

“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, says Aldous:

“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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  21 comments for “Collapse of Outsourcing Giant Carillion May Have Silver Lining

  1. John Miller
    Sep 15, 2018 at 11:02 am

    I’m honestly surprised the Uk does not have such protections, it’s almost a wonder that Carillion style bankruptcies didn’t occur sooner.

    • Crysangle
      Sep 15, 2018 at 12:47 pm

      It is very bad practice, and common worldwide in many areas of business and bureaucracy. The effect is to gain leverage over the other, it places the retainer in a position of power because of the reliance that is created for final payment or service. If you give people this advantage, and it is not supervised or ringfenced, you are giving someone else the opportunity to screw with you. Entities that occupy positions of dominance or near monopoly are all the worse due to the sheer arrogance that may form in their rank. Here is another smaller example of lack of obligatory ringfencing. Sometimes it is just poor practice, but it runs all the way through to false government promises that lack feasible accountability :

      http://www.theolivepress.es/spain-news/2018/09/13/exclusive-british-expats-in-spain-lose-millions-following-mysterious-collapse-of-foreign-exchange-firm/

      • d
        Sep 16, 2018 at 5:43 am

        MOST SUB-CONTRACTORS GET A GUN HELD TO THEIR HEADS “BIG” RETENTION’S, PAID WAY LATE, OR NO WORK.

        “If you wont do it, the illegal immigrant down the road will, and cheaper as well.”

        Law or no law thats the reality for subbies who should be full time employees of the agents they are subbing to.

        The agents wont give them job’s, as subbies unlike employees, can be released immediately with no payment.

        Reality and the law are regularly worlds apart..

        • Crysangle
          Sep 16, 2018 at 10:13 pm

          Is so, but if you eliminate bad practice by law, it improves the accuracy of pricing across the board. The subcontractor is not there to gamble on if the project is a success, better to let even illegals work for not getting paid.

  2. nick kelly
    Sep 15, 2018 at 1:05 pm

    I have a family member who was stiffed by a big outfit for a bunch of extra work he did on a large construction project.
    The Site Super was in over his head and devolved a lot of managing to this guy, including extra hours. He got repeated verbal assurance that ‘we”ll look after all this’

    When he submitted a a bill low six figures HO eventually replied that the Super was not authorized to hire extra management.

    He went to a lawyer, who fortunately was a friend, who talked him out of litigation, as it was unlikely to recover its own cost even if successful.

    But he found out that not paying small guys in full is so common its part of big- guy unofficial accounting. They have very cheap (volume) legal work and know the little guy doesn’t.

    An absolute poster child is the Trump organization, which when it was building considered it a point of honor not to pay the contract price.
    Ironically among the many litigants who didn’t take the haircut, were a number of lawyers.

    • 2GeekRnot2Geek
      Sep 15, 2018 at 2:01 pm

      Nick,

      The Trump organization: Don’t forget all the contractors he put out of business in NJ when the Taj Mahal and the Bay Casino’s declared corporate bankruptcy in the early 90’s. And all the bondholders that took a bath in the same bankruptcies.

      And yes, it’s amazing how many contractors get stiffed in a handshake/verbal deal.

    • W T Frogg
      Sep 15, 2018 at 4:23 pm

      Holiday Inns in the Toronto area used to pull the same stunts. Run up their tabs with small contractors then file for bankruptcy and have a subsidiary pick up the pieces for pennies on the dollar..rinse & repeat. Had a few friends in the various sub trades go breasts vertical that way.

      I used to sell to OEMs like Generous Motors, etc. They were chronic 120 days for payment after grinding you down to cost + 5%. My bonuses were based on my Gross Margins…….I finally told GM to take a hike. I watched as a competitor went out of business trying to service them for peanuts. LOL.

    • Gershon
      Sep 15, 2018 at 5:09 pm

      “When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it.”
      ― Frédéric Bastiat

  3. raxadian
    Sep 15, 2018 at 1:08 pm

    Simply put when there was wind on the sails, regulators were comvinced doing stuff like this would “harm the construction boom”. Now the wind is gone and the UK needs to build a better reputation thanks to Brexit effects.

  4. kk
    Sep 15, 2018 at 2:36 pm

    “The strong do what they can and the weak suffer what they must.” Why are you complaining about a fact of nature?

    • Crysangle
      Sep 15, 2018 at 4:29 pm

      “Be nice to people on your way up, because you’re going to meet them all on your way down.”

      Jimmy Durante.

  5. Bill from Australia
    Sep 15, 2018 at 4:45 pm

    We should look further into the bureaucracy that allows blatant mall practice that CAILLION, did and many other large companies do daily as a
    means of (normal) business. By contracting out social services such as prisons, health care,law enforcement to entities whose sole entire aim is to profit, governments abnegate their social contract with society.

    • Gershon
      Sep 15, 2018 at 7:51 pm

      By contracting out social services such as prisons, health care,law enforcement to entities whose sole entire aim is to profit, governments abnegate their social contract with society.

      Concur completely, but it’s worse than that. All of our institutions of governance have been completely captured by the financial elites and corporate interests. Instead of being responsive to the needs, concerns, and aspirations of the 99%, government has become an adjunct to a corrupt and venal oligarchy. And since the population has been so dumbed down by our education system and the media, they graze obliviously on the mushrooms growing from the bovine excrement the MSM strews across their pastures, and vote for the crony capitalist status quo every election.

      • Crysangle
        Sep 15, 2018 at 9:50 pm

        You will confuse yourself on this I think. Firstly capitalism and public service are two different creatures. Public service is based on the notion of enforcing order, or the moderation of the use of force. In itself it is not productive, it is designed to allow private capitalist endeavour to flourish in a secure environment. It draws from the productive achievement of that endeavour to fund itself. The traditional manner of doing that, until monetarist policy became the norm, was via taxation. So you end up, under that scenario, with a minarchic setting, where the civil service is directly responsible for the services Bill mentions. It is a fair compromise, capitalism and the communism of public service having a clear separation which is negotiated by parliament and democratic representation in parliament. So far so good, however in the space of time surrounding the start of the last century, for various reasons, the veto of the upper house (tradition) over the budget was lost to the commons. Social policy and financial engineering of government spending took off, the final result being the complex national economic and social management we have today. However the capture of government service by the financial elites and corporate interests, as you put it, is nothing less than own government selling off its responsibilities. They were not captured, the government is corrupt of itself in the system it has purposefully and independently chosen . So today we even have respectable sources confounding this reality, I was just reading

        https://blogs.spectator.co.uk/2018/08/the-true-cost-of-the-carillion-wreckage/

        that states:

        “For the manner in which Carillion was run, and was allowed to be run, was scandalous. It’s become a byword for everything that’s wrong with British capitalism – a Corbynite alibi to expand the frontiers of the state.”

        which turns the whole topic into a partisan muddle, insisting on mixing government duty with capitalism with politics. Until they reset the boundary between government and individual, between public and private, between communism and capitalism, to a clearer reality of full public accountability to the public , to a set of limitations that bar opaque government improvisation, this whole surreal show will only continue, unfortunately. If it does continue like this, we will end up with a reality of total government administration, it is already going well in that direction in terms of various forms of administrative overeach.

        My two cents.

        • sierra7
          Sep 16, 2018 at 2:36 pm

          “Capitalism” is a game.
          All games need rules.
          The rules that oversee “capitalism” are called, “regulations”.
          The monied classes have overpowered (bought; “captured” if I may) the legislatures abilities to enforce those “rules of the game”.
          We have the results.
          Disaster.
          Couldn’t have been more exemplified by the GFC in early 2000’s. (Regardless of Lloyd Blankein’s statement before Congress that GS was, “….doing God’s work!”)
          We need a “firewall” of enforced “regulations” to protect the commons from the rapine of free market capitalism.
          Period.

        • Crysangle
          Sep 18, 2018 at 10:05 am

          Rounding that off, you end up with a government that is still able to sell off national assets. However, the decision to do so is visible and transparent , a choice open to public scrutiny and rejection. It may also subcontract services but holding ultimately responsibility. Any contract will not involve government liability ( eventual debt) , but only a pre-agreed payment taken from taxation. What it cannot do is subscribe to PPI shenanigans where it acts as financial guarantee, where failure is its financial liability, where further investment, by public debt, may be used to cover failings.
          As for the central bank, well it will have no clothes given that the meaning of its currency is largely guaranteed by public debt. It might continue under the existing fiat system, but people will question its authenticity, and would likely rebel if it attempted private sector QE – it would be seen as no more than a print for the privileged, the wealthy, it would be understood as a corrupt institution.

          This is why central banks keep gold. If the system goes kaput, they will likely have to return to sound money. Alternatives are a global currency, or blockchain currency. These might be purposefully phased in as modern fiat becomes unworkable due it losing its meaning, cause of no honest price discovery. Natural price discovery is important because it reflects the individual choices of the population, it is organic and leaves the choice of the time value of money in the hands of the actors, people. It is counter-intuitive that many people making own choices in saving or spending should give a more rational market time value than a single centrally administered decision on what that value should be. It is touted that central rate setting is a guarantee to the stability of the economy and value, that central economic management is a leveler that ensures an optimal evolution of combined activity. This may or may not be true, but foremost it is dis-honest from the start not to allow people their choice of non participation in that endeavour. To the individual being it is his choices and the product of them that are enriching. This is capitalism, you are rewarded in accordance with your effort, according to your ability to achieve. It is not in principle at the expense of others, though given that opportunity ( central planning, opaque law, corruption, socialism) it may well take that direction. I look at the world and its endless possibilities, and all I see is mankind fighting over, and conning others for, the pre-existing scraps…instant self reward, with no incentive due to this attitude to pursue own creativity because of the scales are so heavily tipped against receiving the rewards of own endeavour. It has all become a vain attribution of social recognition and empty, formatted, diploma.

          Even the above original suggestion leaves room for many kinds of policy choice. I am open minded as I basically shun larger systems anyway out of disgust, so I am able to look on it all in a detached manner, theoretics. So you can have a system of social credit replace government allocation of services – you tax the required % and it goes directly equally to all people. They then make their choices in the private market. You can choose a hard money system with very low taxes, just enough to provide public safety, property right enforcement, national defense. You could even end up with a choice of anarchy, where the “government” is chosen to deregulate everything ! What you will not have though is the current obscene manipulative fudge with its insulting excuses forced on people as reason.

          People see force as someone armed, or someone who frames a circumstance leaving no choice. That is not the equation with government though, even if it holds those possibilities. Nowadays it is actually an accepted reality we are trained into, where we are dependent, and relatively helpless outside of it. It is self reinforcing, moderation being left to the hands of others.The social impetus is dominated by predetermined themes that are owned and disseminated, that do not originate properly from own consideration, from own experience, or tradition even. The experience we draw from is one that has been pre-shaped for us. It is no wonder people cannot get a grip on any proper base to start their enquiry, that what they have to compare to is neither sound as reference. This is how nations dissolve themselves, where no one really notices it till they find that they have no meaningful start point to return to, and what is offered as future is an ever narrowing blinkered view. It all only looks good while it does, while it seems to be working, but when sentiment and perception change, and they can turn on a dime once they are cooked, it all becomes a whole new unknown world.

          Well Wolf, it costs me to extend my view, even if it is a relief to state it, and your articles are inspiring, or more to the point the perception that goes with them is. I don’t expect you to post this, it is so you know where I am coming from… if you do post it then not without the previous reply please. I am very open source, and direct, so I hope to add something of a challenge to anything, hopefully taken constructively, even if it crosses anyone’s own views. You keep politics off your site, that is very wise, one reason I like economics is you can talk politics without talking politics, go figure, but the truth is that under the current system money and finance are political tools, and vice versa. What to do. When I find I have something to say I just go right ahead, though I fully understand the need to keep your comment section diverse and therefore balanced, so I will do my best to keep any future comments well focused, and that should shut me up a bit :-).

  6. nick kelly
    Sep 15, 2018 at 6:48 pm

    I was surprised while reading the Globe and Mail legals a few months ago to see about a quarter page of about 8 Canadian Carillion subsidiaries declaring bankruptcy.
    These tentacles reached a long way.

  7. Nash
    Sep 16, 2018 at 8:32 am

    Yes very interesting but did the Canadian and us protection ie putting a lean on the project help the Canadian businesses that suffererd when carillon purposely frauded their contractors .I believe it did nothing as it was a foreign entity and the subcontractors worked for it .
    This is an ingenious way to loophole the law . Ie say my name is Nash Trump all I have to do is build a Trump tower in Vancouver hire a fraud company that is foreign and that I created …have that company go bankrupt ,,,,,and then tell the subcontractors to go after the foreign company while I run for prime minister .remember a lot of snow clearing contractors in Ontario were defrauded who did they put a lean on ….l guess mother nature is going to court ……

  8. John Henderson
    Sep 16, 2018 at 12:15 pm

    Capitalism U.K.style.
    Creative destruction.
    NO consequences

  9. Sep 17, 2018 at 3:51 am

    Perhaps the blockchain smart contract method might beat these parasites. I think there is a good opportunity for a company to prepare a standard smart contract format for sub-contractors which will ensure that they get paid automatically as the work is completed according to the contract.

    However, from the main contractor’s point of view, I can see why a retention might be required because SME’s do often fail on quality delivery as I am sure most of us have suffered during home improvements for example.

    Great opportunities here, I think

  10. George McDuffee
    Sep 17, 2018 at 1:20 pm

    One “solution” to the late/non payment problem could be through the tax system. In the US, at least theoretically, income tax is owed on anything received of value, such as employer provided housing or meals or personal mileage in a company car, and tax is collected. Such a late payment tax would be cheap to collect as all large companies maintain computer data bases of both accounts receivable and accounts payable. Legislate that late (>30 days ?) payment of a payable item is constructively a loan, and should be taxed assuming the highest legal rate of interest. A surtax may be required if this late payment tax is below the cost avoidance/profit to be gained by slow pay,

    The suggested remedies for the related retention problem such as mandating escrow accounts with a fixed distribution dates or depositing the retention payments in government accounts, and limiting the legal retention rate seem adequate. In bankruptcy proceedings, retention payments would seem to be analogous to wages and these should be ranked immediately behind wages and before unsecured creditors in payment priority.

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