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Carillion: implications for public contracts

Lexis Public Sector 146x219With the number of Carillion’s contracts with the government running into hundreds, Ruth Murray analyses on LexisPSL the impact of Carillion’s collapse on its public contracts and outlines the next steps that authorities should take.

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Original news

Government takes on public services following Carillion’s insolvency, LNB News 15/01/2018 83

The government has committed to deliver all public-sector services following the insolvency of Carillion plc. Carillion announced the decision to initiate insolvency proceedings following a meeting with its bankers and lenders. The official receiver has been appointed by the court as liquidator, along with partners at PwC that have been appointed special managers. The government has also said it will provide the funding required by the official receiver to maintain public services.

What is the impact for public contracts awarded to Carillion?

Depending on the drafting of the contract, termination may have occurred automatically on the appointment of the liquidator (for example) for other contracts, the authority’s right to terminate the contract may have crystallised and so authority will need to take the prescribed steps in order to effect termination.

Typically, insolvent entities have little or no cash reserves. This means that an authority has, practically speaking, no viable target to recover contractual damages or losses under indemnities.

Where an insolvent Carillion entity has given a parent company guarantee to an authority, that guarantee will be essentially worthless and the authority will be relying on the covenant strength of the prime contractor (at least until alternative security is obtained).

What are the potential options for contracting authorities (including central government departments) who have tendered public contracts to Carillion?

Contractually speaking, the potential options which may be taken in any particular case will depend on the terms of the contract. Typically, where a contractor becomes insolvent, authorities may be able to (or are required to):

  • terminate the contract
  • suspend the contract, or
  • step-in to the contract

Practically speaking the position is far more straightforward. The final outcome of the liquidation process is the liquidation of the company—there is no expectation that the company will manage to trade its way out of insolvency.

Accordingly, the only real option for many affected authorities will be to prepare and implement its roadmap for how the project or services will be delivered into the future, without Carillion.

What are the key legal or regulatory issues that authorities will need to consider?

As long as there is a contractual relationship in place between the authority and the insolvent Carillion entity, the authority will need to comply with the terms of the contract—including payment (for undisputed sums which are due) and the manner in which it terminates that contract. Failure to do so could risk the liquidator seeking contractual remedies from the authority.

Where an authority decides to procure a replacement contractor, the authority will need to comply with the relevant public procurement rules. Depending on what is being procured, some authorities may look to use their emergency powers to undertake negotiated procedures without notice, or rely on the safe harbour provisions relating to insolvency for modification which can apply in some procurement scenarios.

What can the government do to safeguard their contracts and to ensure business continuity against this sort of event?

The risk of insolvency is part-and-parcel of the public sector procuring goods and services from the private sector, but steps can be taken at the procurement stage to safeguard the contracts and continuity of supply that include:

  • contractual mechanisms to require enhanced security where a ‘financial distress event’ has occurred (both for the contractor, key subcontractors and any guarantor(s)), with an ability to terminate where there is a failure to provide that enhanced security
  • requiring the contractor to take out bonds with banks (rather than relying on corporate guarantees) to cover key liabilities or advance payments made to the contractor
  • obtaining collateral warranties from key subcontractors so that the authority maintains a right of recourse to those subcontractors where the prime contractor becomes insolvent, and
  • ensuring that rights to terminate the contract on the basis of contractor insolvency are drafted to crystallise as early as possible in the insolvency process

During the life of a contract, it is important to continually monitor the financial health of key contractors (and where relevant, key subcontractors and guarantors of those key contractors) so that potential problems are identified at an early stage and contingency planning can take place.

What are the potential legal implications for joint ventures in this situation (ie where a joint venture (JV) partner collapses with a public contract still ongoing)?

Where the authority has entered into a contract to be delivered by a JV entity which is part-owned by Carillion, the authority should look at the nature of those arrangements with the JV entity.

Where the JV entity is a corporate vehicle then the authority will need to consider whether that JV company will have the resources it needs to satisfy its obligations under the contract, and whether any (remaining) contractual security is sufficient for the authority’s ongoing purposes.

Where the JV entity is unincorporated, the authority should look at whether the JV partners are liable on a joint and several basis (such that the remaining partner(s) remain(s) liable for the past and future failure of Carillion to perform its side of the bargain), and assess the financial covenant of the remaining JV partner to establish whether the JV partner is capable of delivering against its obligations or pay any damages which are due to the authority under the contract.

What are the possible next steps?

Next steps to be taken immediately:

  • identify all project or contracts which might be affected by the insolvency (directly and indirectly) — identify if Carillion is a prime contractor, a joint venture partner, key subcontractor to another prime contractor or guarantor, and
  • analyse the contracts to ascertain what actions the authority is obliged to take and what options are open for the authority (taking professional advice if there is any doubt as to the most advantageous course of action or how to implement that course of action)

In the short term:

  • the authority should engage in the liquidation process so that the authority can participate in any distributions by the liquidator, and
  • contract management teams should engage with the authority procurement team to formulate strategies for the future delivery of the project or services

Are there any other important points worth mentioning?

Authorities should look beyond the primary contractual relationships—the insolvent Carillion entities were the customers and subcontractors to a large number of other contractors which supply goods and services to public bodies.

With Carillion being such a significant player in the construction and services industry, many contractors may be put in financial distress as a result of orders not being fulfilled or invoices not being satisfied by Carillion.

Now would be a good time for authorities to make contact with their key suppliers to:

  • ensure that they have appropriate business continuity measures in place, and
  • assess the continued financial viability of those suppliers

Authorities should take action now so that the risks of further contractor insolvencies in the future are mitigated.

The views expressed by LexisPSL's Legal Analysis interviewees are not necessarily those of the proprietor.

This article was originally published in LexisPSL Public Law. If you would like to read more quality content like this, then register for a free 1 week trial of LexisPSL.

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