Legal: Carillion and a shift in risk

The collapse of Carillion has left hundreds of contracts hanging on unfinished schemes: whoever takes over these projects should beware not to repeat Carillion’s mistakes in accepting too high a level of contractual risk.  

Following three profit warnings in recent months, the collapse of Carillion under a mountain of debt could hardly be described as a surprise. The fact that Carillion has entered compulsory liquidation may raise eyebrows. Administration would have allowed the company to continue operating whilst buyers were sought for those parts of the business that remained viable; liquidation is an acknowledgement that, by the time it collapsed, Carillion simply had no assets to sell that anyone would have been interested in buying. All that was left were the contracts.

Carillion, in its desperation to bring in cash to pay subcontractors, suppliers and lenders, agreed onerous terms on numerous contracts

What happens to the contracts?

So what about those numerous contracts, including the £1.4bn High Speed 2 contract awarded to a consortium including Carillion as recently as July 2017? One national paper has run an article entitled The Four Contracts that Finished Carillion; but if poor choice of contracts has been the root cause of Carillion’s failure, will other contractors be circling to pick those contracts up? And if so, on what basis? What are the opportunities and risks for those contractors with the inclination and resources to bid for contracts formerly let to Carillion?

The key point to note for any contractors considering taking on post-Carillion contracts is that, following a contractor insolvency, all bets are off. Any building contract is likely to include a clause (for example, clause 8.5.1 of the JCT Standard Building Contract without Quantities 2016 Edition) allowing the employer to give notice terminating the contractor’s employment in the event of contractor insolvency. The employer is then expressly allowed to employ and pay other persons to carry out and complete the works, and recover these costs and any other costs arising from the termination from the previous contractor. 

In the case of termination for insolvency, this right is likely to be of no practical benefit to the employer, as an ordinary unsecured creditor. Liquidators also have the ability to disclaim onerous “property”, such as unprofitable contracts or elements of contracts which would otherwise be a burden on the liquidated company.

Ironically these are not bad times for all contractors, with workloads rising moderately through to Q4 2017

Renegotiating risk

Any contractor considering taking over work previously let to Carillion should be alive to the opportunity to renegotiate the contractual risk profile to avoid making the same mistakes as Carillion. Of the Carillion projects that are well known to have gone seriously wrong, one was the construction of the Royal Liverpool University hospital. Significant delays and additional costs on that project were caused by the unexpected discovery of extensive asbestos contamination. There is every reason why an incoming contractor should seek to exclude liability for this risk – or negotiate an appropriate premium for taking it on. 

Carillion, in its desperation to bring in cash to pay subcontractors, suppliers and lenders, agreed onerous terms on numerous contracts – unacceptably low profit margins; unknowable risks such as asbestos contamination, ground conditions or the interface with existing structures; unachievable programmes and punishing liquidated damages provisions. There is simply no reason why an incoming contractor could be expected to take the same contractual risks that Carillion did, and ultimately paid the price for.

From the perspective of an NHS trust, or any other employer, a half-built project with no prospect of a replacement contractor represents an unacceptable waste of money. Contractors bidding to take such projects on are in a strong position to cherry-pick not just the contracts they want to bid for, but the contractual and commercial provisions they are willing to live with to complete the work. 

Ironically these are not bad times for all contractors, with workloads rising moderately through to Q4 2017 and steady if unspectacular growth in some sectors – certainly far removed from the lean times of the last financial crisis. 

It was already to some extent a contractor’s market. With the pool of available major contractors now reduced by one, and with the very unfortunate likelihood that the pool of specialist subcontractors may also be about to diminish as a result of Carillion’s failure, the net result may be expected to be increased costs for employers seeking bidders to complete their projects. 

Employers let down by Carillion can also expect to have to accept a greater share of the development and construction risks in their projects than they would have before Carillion’s collapse. Incoming contractors will know that they do not have to take all of the existing contractual terms and scope of work, or nothing – the opportunity is there to achieve a better balance of risk than Carillion was able to manage, and by doing so avoid its fate.