Eight Years since Carillion: a Memento Mori for Construction Giants

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A long read: Eight years after the monumental collapse of construction juggernaut Carillion, the UK’s accountancy regulator has banned five of its former executives for acting recklessly. Breaking Law casts an eye back to the failure of the listed multinational and the lessons learned in its demise.

On 12 May, the Financial Reporting Council announced that it had imposed sanctions on Richard Adam and Zafar Khan, two former Group Finance Directors of Carillion, as well as three unnamed senior accountants. The FRC found that the former officials had “acted recklessly and failed to act with integrity in connection with the preparation of accounting information” for the company’s financial statements prior to its collapse.

Adam and Khan have been barred from the Institute of Chartered Accountants in England and Wales for 15 and 10 years respectively. They also receive combined fines of £775,000 – reduced to just over £280,000 to account for fines already imposed by the Financial Conduct Authority and a settlement discount.

The unnamed accountants have been barred from their relevant supervisory bodies for between 2 and 8 years, and face fines totalling nearly £100,000 after settlement.

All six individuals have also been issued with “a severe reprimand”.

The FRC decision comes three months after Carillion’s former CEO Richard Howson was fined £237,700 after the Financial Conduct Authority found that he was “aware of serious financial troubles” and “failed to reflect this in company announcements or alert its board and audit committee, leading to poor oversight”.

But what kicked all of this off?

Let’s go back to the beginning of 2017. Carillion is one of the biggest multinational construction companies in the UK, employing around 45,000 people globally. It’s a key public contractor with around 420 contracts with Theresa May’s government. It offers facilities management services for its projects, which include prisons, school dinners, traffic control and hospitals. It also has operations across the world and supplies construction services to the government of Canada.

It has an impressive roster of projects on its books. The Royal Opera House, the Tate Modern, the doughnut at GCHQ. Even the plans for the HS2 railway line have fallen into Carillion’s lap. And last year, those books looked really good – sales of £5.2 billion and a market capitalisation of nearly £1 billion.

Fast forward to July 2017. Carillion issues a profit warning, announcing an expected provision against its construction contracts of around £845 million. Two months later, it gets worse: the company reports a further provision of £200 million and a first-half loss of £1.15 billion. And another two months later, we get a third profit warning and a disclosure that it will probably breach its banking obligations in December.

By the time the calendar rolls into 2018, Carillion has no choice but liquidation. Last-chance rescue talks have failed. The banks have refused to give it more money. The government has refused to bail it out with a £223 million loan to convince the banks. Carillion is over. In the middle of January, it files for liquidation with the High Court.

No insolvency practitioner is willing to act as an administrator. The High Court therefore appoints an employee of the government’s Insolvency Service and the Official Receiver to manage the liquidation. Employees of PwC also step in to act as “special managers” in support of the Official Receiver.

What happened next?

Crisis, dismay…and some English stoicism. Carillion’s shareholders receive nothing, and the government is staggered. After the shock of the first profit warning in July 2017, the Cabinet Office started contingency planning, but had not been able to establish a complete list of the government contracts that might be affected until at least December.

But as Carillion collapses, the government tells the company’s staff to report for work as usual. Many of the larger projects are taken over by Carillion’s joint venture partners, and government departments begin to establish companies to run the facilities management contracts.

So what went wrong?

A multi-faceted disaster. Firstly, massive expansion fuelled by massive debt, offset against massive goodwill.

Formed after a demerger from Tarmac in the late 1990s, Carillion made a series of acquisitions to quiet the competition and position it as a market-leading construction company and outsourcer in the UK. In doing so, it paid more than the companies were worth (goodwill investments). According to a report by the International Compliance Association, the overpayments were justified as investments because of positive forecasts – but when those didn’t work out, the company took years to write them in its books as losses. The ICA says Carillion had an estimated £1.57 billion of goodwill payments in its accounts which never existed.

In the meantime, it was taking on a serious amount of debt: between the end of 2009 and the start of 2018, its debt more than quintupled from £242 million to £1.3 billion.

Meanwhile, it was developing a serious pensions problem. Acquiring companies also meant acquiring their pension schemes – and deficits. In 2018, the work and pensions committee said that the company’s former directors had ignored repeated warnings from pension advisors that it was chronically underfunding its pensions schemes (relied on by 27,000 people). By May 2017, pensions advisers were warning that its pension deficit was equivalent to the company’s entire stock market value. Dentons estimated that the combined estimated pensions deficits of all 360 Carillion companies was around £1.8 billion by the end of 2016.

Carillion had tens of thousands of suppliers, and a habit of paying them late. Not only did it force standard payment terms of 120 days on its suppliers, it also used an Early Payment Facility (EPF) scheme to allow them to be paid earlier if they accepted a discounted rate.

According to credit ratings agencies Moody’s and Standard & Poor’s, this was concealed from financial backers. Instead of presenting the EPF liability to the banks as “borrowing”, the agencies argued that it was presented as liabilities “to other creditors”, hiding as much as £498 million.

Despite all these issues, Carillion continued to pay large dividends to shareholders. And therein lies the real issue: poor corporate governance and poor operational management. The Work, Pensions and BEIS Committee found that the collapse “tested the adequacy of the system of checks and balances on corporate conduct”. It found the board was either unaware of its duties under the Companies Act, or negligently ignorant of the “rotten culture” at Carillion.

It accused them of pursuing short-term gains over long-term sustainability, a failure to scrutinise or challenge, and the use of aggressive accounting practices to present an overly optimist outlook. Senior staff received high salaries and bonuses while the company’s finances dipped and the pension deficit soared.

The climate of financial misreporting led to the latest FRC and FCA decisions, as well findings against Carillion’s auditors

But it was a diamond mine for lawyers

The collapse was a lucrative business for lawyers (and not just the insolvency ones ). The failure of Carillion triggered instructions left, right and centre.

In the days leading up to the company’s collapse, Slaughter & May reportedly made £8 million, raking in its last £1 million the day before the company went insolvent. The collapse also gave rise to litigation, with Hogan Lovells instructed in 2023 for a three-year term to pick up the pieces.

Outside of Carillion, there were around 11,500 subcontractors - many of whom found themselves looking down the barrel of non-payment or delayed payment. The impact on the supply chain was therefore widespread, with contracts being varied or terminated all over.

So, a slew of work for construction, projects, insolvency, pensions, employment, finance and regulatory lawyers to bear in mind.

What has changed since Carillion’s collapse?

Well, we’re still waiting for audit reform from the government. A long-awaited bill has been dropped amid fears of increased costs on business and concerns about the lack of parliamentary time (after only eight years…).

The government announced plans in May 2022 to replace the FRC with a new Audit Reporting & Governance Authority (ARGA) with new powers in relation to audit, corporate reporting and directors’ duties and introducing new reporting requirements. Again, this has not happened.

But the FRC and FCA have shown their powers of investigation and the FRC has introduced some new guidance on auditing standards and scrutiny for UK companies. It rewrote its ethical standards for auditors in 2019 and has sought for a split between audit and non-audit parts of the Big Four accounting companies.

In January 2024, the FRC also updated its UK Corporate Governance Code to introduce a new “Provision 29”, to take effect from 1 January 2026. That provision now requires boards to make a declaration in relation to the effectiveness of their material internal controls. For more information on what this really means, the FRC has a handy Mythbuster here.