22 January 2018
On 15 January one of the UK’s largest companies, Carillion, entered compulsory liquidation, putting at risk the livelihoods of 43,000 workers and 30,000 subcontractors. The newspapers, radio, TV and political parties reacted immediately with many and varied claims, some of them inaccurate or exaggerated. The company’s pension scheme, which was indeed in deficit, was reported by one TV interviewee to have been ‘plundered’ by the company. A guest on a local radio station said that the PFI scheme, under which Carillion obtained many of its Government contracts, was a ‘licence to print money’ and the leader of the opposition called it a ‘racket’. The pension scheme deficit has been reported at values varying from £0.5bn to £2.5bn. The auditors have been held responsible, presumably for failing to report that the company was not a going concern. For the sake of the many employees, suppliers and subcontractors who will no doubt suffer in the aftermath of this collapse, let us look more soberly at the facts.
It is true that the company had issued a number of profit warnings and that its shares had fallen markedly in value. (From 237.0p on 2 January 2017 to 18.89p one year later). However its latest audited accounts (December 2016) disclosed net assets of £730m and it was not technically insolvent. It reported a loss in that year of £205m, and interestingly this was after a charge of £439.7m to provide for a revaluation of the pension scheme deficit (of this more below).
As required by statute the directors had considered whether the company was a going concern at the time of the publication of the 2016 annual report (1 March 2017), and the auditors stated in their report that they had checked this assertion and did not disagree. One might, with hindsight, ponder on whether net assets of £730m represent a sufficient buffer for a company with a turnover of £5.2bn, heavily involved in the construction industry whose margins are miniscule and where risks are very high.
A fall in the value of its shares does not directly affect the way a company trades but it is a sign that the financial institutions have lost confidence and should therefore have been a warning. As with many such cases, though, business carries on as normal until a single event starts a landslide. Like the towering display of baked bean cans in the supermarket, everyone knows it is inherently unstable, but is amazed when the small boy, momentarily unsupervised by his mother, takes a can from the bottom row.
The pension scheme
As mentioned above, the deficit was included in the liabilities on the balance sheet. On 31 December 2016 this stood at £804.8m across its 14 pension schemes and comprised assets of £2,572.7m less liabilities of £3,377.5m. Contrary to some allegations there is no evidence that the company extracted funds from its pension schemes; these are held in separate trusts, outside the control of the company itself. The schemes’ assets and liabilities are valued by independent actuaries, using assumptions about future and current obligations to pensioners and about projected investment performance and the company’s future contributions.
Between December 2015 and December 2016 the actuaries revised their financial assumptions, causing a reduction in asset value of £732m (which was partially offset by other movements). Those affected will be employees who participated in final salary schemes. Such schemes have proved generally to be unaffordable, and most have been closed so that those remaining are predominantly the preserve of civil servants and other public sector employees. However the Pension Protection Fund will step in to preserve the rights of those who are already drawing their benefits and will guarantee 90% of the value of the pensions of those yet to retire subject to a cap of £35,000 pa per pensioner. It has been widely reported that this is taxpayers’ money – it isn’t; it is a private scheme funded by a levy on member companies.
The Private Finance Initiative, under which the Government commissions public services and major construction projects from private companies, was already under serious scrutiny before Carillion’s demise. We will see whether it survives. Ironically the public purse has been somewhat protected by PFI in this instance as the losses caused by the failure will be borne primarily by the investors, shareholders and suppliers of Carillion.
Those of us in business will probably agree that the combination of fair competition and the profit motive mostly acts to keep expenses in check and prices down. In the construction industry the process of tendering and agreeing contracts is particularly complex and favours the experienced and wily negotiator. In the early days of PFI the contractors had the best negotiators. More recently better-trained civil servants have been able to reduce get-out clauses, throwing more of the risk onto the contractors. On the other hand, the number of contractors tendering for such projects has declined to the extent that one has to question whether the desired open market actually exists. A recent invitation to tender for the redevelopment of a London hospital attracted only two bidders. So the lack of bidders might be the main reason why the Government continued to award contracts to Carillion even after profit warnings had been sounded.
What finally brought about Carillion’s demise was a series of major Government contracts, on which margins were already extremely small, coming up against the kind of snags often encountered in the construction industry, and the company finding it contractually impossible to pass on the additional costs.
It seems that the members of the company’s pension schemes will largely see their benefits preserved. The many public service contracts undertaken by Carillion will have to continue uninterrupted and the large construction projects will go ahead after a pause to find alternative contractors. So the majority of the company’s UK employees may well find themselves in the same job with a different employer.
Those who will no doubt be permanently affected are the unsecured creditors, many of them small sub-contractors and suppliers. It is estimated that £2bn is owed to about 30,000 of them. Smaller business will be seriously affected by a double whammy of both bad debts and the loss of a major part of their future revenues and may see themselves joining Carillion and be forced into liquidation.
If your business finds itself endangered by the Carillion collapse please get in touch with me. I may be able to help you to draw up a survival plan or help you to negotiate with your finance providers and protect your interests.