Young: scale of Carillion insolvency masks fundamental problems

Senior associate, commercial litigation and dispute resolution team, LA Law

19 Jan 2018

As is often the case with high profile business failures, Carillion’s insolvency has a number of unusual features, not least its political dimension. In other ways, it is simply a familiar story on a larger scale, says Nathanael Young, senior associate in the commercial litigation and dispute resolution team at SA Law

For example, take the depressing outlook for Carillion’s unsecured creditors. Ordinary people may be shocked at reports it is expected to pay out less than 1p in the £, but this is far from unusual in an insolvency context.

Once a business fails, secured lenders will often take the most valuable and realisable assets, while assets such as goodwill evaporate. While the costs of the insolvency process are often a source of concern to creditors, those costs are rarely the reason for their losses.

Another example is the impact its demise will have on third parties. Carillion was particularly large, and was heavily involved in public contracts, so these effects are high- profile. On a smaller scale, however, insolvency of one business has a knock-on effect on many others.

For small to medium-sized businesses (SMEs), bad debts – particularly the effect of bad debts on cash flow – often prove fatal. Failure of an existing trading partner is an even bigger issue, as it affects not only cash flow, but the ability to trade profitably in the future.

Sometimes, saving the business may require radical changes. Even if this is not the case, there may be considerable uncertainty and advice required over the validity and effect of existing contracts, and the rights that have accrued under part-completed contracts.

This is particularly so given the rapidity with which businesses can fail. It was not until July 2017 that Carillion’s problems became public knowledge, when it issued its first profit warning.

Even then, the language used by its management did not suggest that its future was in serious doubt. Six months later, it was all over.

Who is responsible for demise of Carillion?

This leads on to one of the most interesting aspects of the Carillion case, and one that will become increasingly prominent as the immediate issues are resolved – the question of who or what is responsible for its demise.

It is normally the management that has the first chance to explain where the blame lies, and they will often point the finger towards lenders who have hampered efforts to rescue the business. Carillion seems to be no exception.

In reality, this often represents the symptom as much as the cause. When a business gets into difficulties, lenders will always face a difficult decision on how long to keep supporting them.

The more interesting question is how the difficulties with the business first arose, and what was done at that stage.

It is still early days. Given the high profile of the Carillion case, public attention is already turning to the allocation of blame for the failure, with talk of a ‘fast-track’ investigation into its directors and rumblings over the auditing of its accounts.

This is a very difficult area and hindsight can often be unkind. The scale and nature of problems facing a business are not always easy to assess. However, business owners should have no doubt what is at stake. They should also realise the importance of acting quickly. Even on a small scale, the window for turning round an ailing business can often be brief.

Rescue culture

This is where advisers have a particularly important role. It is not uncommon for businesses to assume that what worked in the past will work again in the future, and that patience is all that is required for them to trade through their problems.

It can take time for businesses to come to terms with the extent of the changes that they need to make. Business acumen is not enough in this situation, particularly where the management find themselves in an unfamiliar situation, while shortcomings can be cruelly exposed.

A longstanding aim of insolvency rule-makers has been to foster a ‘rescue culture’. Their efforts have not been an unmixed success, but there are plenty of ways in which action can be taken to limit the damage of business failure. Unfortunately, this chance is still missed all too often.

It is too early to tell exactly what precise mistakes led to the failure of Carillion. It is likely to take years to untangle the various issues and reach even provisional conclusions. Nonetheless, its spectacular collapse is a reminder of something usually seen on a smaller scale - the damage and disruption caused by uncontrolled business failure.