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15 January 2018

138: Goodbye to Carillion, hello to a rethink on performance security?

The Carillion brand was a Tarmac demerger launched to great fanfare in 2000. If you can, picture a cocktail party at the Tate Modern where a string quartet memorably played in the turbine hall inside the legs of a Louise Bourgeois spider (I was there). The brand name might have been new, but Tarmac, formed in 1903, was a much loved household name. Incidentally, the demerged aggregates business, now Lafarge Tarmac, sails on under new ownership.

The Carillion rebrand (it means a peal of bells, apparently) represented their focus on different markets being facilities management, with a particular emphasis on public sector projects. This has self-evidently not been successful. When the dust has settled, conclusions will be drawn as to cause.

However, it seems this liquidation represents perhaps the failure of the biggest construction business since John Laing’s construction arm suffered heavy losses on the Cardiff Millennium Stadium and was sold to O’Rourke for £1 in 2001. Carillion was a massive undertaking with a turnover to match. It acts as a salutary reminder that no one is ‘too big to fail’.

‘Watertight’ (for which read onerous) contracts with big companies can give a false sense of security. They’re only as good as the client’s ability to enforce them. A developer embarking on a project should ask itself the following:

What is the contractor’s financial standing (bearing in mind that a good covenant today does not mean one tomorrow, or 12 years hence)?

Is your procurement adviser skilled in assessing the likely medium term trajectory of its business – accepting that even they don’t have a crystal ball and that anything can happen? What is the ‘word on the street’? Are there signs of strain? Are they taking on quality work they can service, or too much, ‘buying in turnover’? Rumour and gossip should not prevail, but awareness of it will enable you to ask pertinent questions.

What performance security can they give?

Most contracts provide for a retention of 3-5%. You could ask for more, but the financing costs of this (they are loaning you money though they will back to back this with retentions to sub-contractors) will add to the bottom line of the contract or increase the very financial strain on them which you should seek to avoid.

You can ask for a performance bond, which is an insurance or bank backed instrument able to pay out, usually, up to 10% of the contract sum, if they are insolvent or terminated for breach, so the project can remobilise without them. They may restrict the availability of these, given they are akin to an overdraft so only so many can be issued in a given period. They may also be able to provide a ‘parent company guarantee’. This is in inverted commas because developers don’t always check the standing of the ‘A N Other’ company offering the guarantee, and whether it is meaningfully superior to that of the contractor. How long is it for? Does it cover all obligations on a back to back basis? Is it for the whole of the 6/12 year post completion warranty period or only up to PC?

Whatever the companies ‘on the hook’ look like financially right now, things can change.

Usually, there is nothing to stop the contractor and/or guarantor restructuring and diverting assets away from the companies with the obligations, leaving the developer and other stakeholders high and dry with a worthless contract. Don’t just assume that the covenant behind the obligations will live on to the end of the limitation period. Should you put something in the contract about this, requiring them to inform you of significant changes and offer replacement security?

What about all those paid for materials?

To whom do they belong? Can you secure your ownership by ‘vesting’, bonding or similar arrangements?

How quickly can you terminate if there are signs of trouble?

Under the JCT contracts, you can terminate if the contractor is formally insolvent. However from experience, contractors under strain stagger on for weeks or months, site presence and level of engagement gradually waning to the merely cosmetic, short of actual abandonment. Their staff are only human. They’re wondering how long they will have a job.

Does your contract provide for these circumstances – ‘failure to proceed regularly and diligently’ being notoriously difficult to prove? Are your team attuned to early warning signs? Have they noticed discontent amongst sub-contractors? Are these the only ‘bodies’ on site or is the job still being actively managed by the contractor’s own senior staff? Do any ‘throw away remarks’ at site meetings give cause for concern?

How quickly can you recover if the worst happens?

Do you have warranties from key sub-contractors and sub-consultant designers, including novated designers allowing you to step (back) into their contracts?

If you are relying on selling or letting the development is that on the basis of a 12 year workmanship and design warranty which you may not get?

Will a new contractor step into the breach? (Spoiler alert – the answer is probably no, or only to a limited extent). Latent defects insurance to cover this loss of recourse can be put in place retrospectively, but it is easier and cheaper to arrange this before works start on site.

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