Carillion, risk and the Public Services Act

Much more than a construction company, Carillion badged itself an 'integrated support services business.' In 2016, Carillion had sales of £5.2bn, with an impressive market capitalisation of almost GBP1bn. The following year, the company collapsed under the weight of GBP1.5bn of debt, despite attempts between Carillion, its lenders, and the government to reach a suitable restructuring deal. Its demise immediately raised questions as to how the company had continued to secure new contracts from local authorities and led to a review of the awarding of large contracts.

The power of legislation

According to the Public Services (Social Value) Act, winning bidders must prove that the way they do business positively impacts the social and economic values of their area, incentivising good practice and rewarding companies that support communities. The rules should naturally favour local, SME-sized businesses

However, at least 25 local councils had contracts with Carillion at the point of its demise, for services including catering, cleaning, major engineering, library management and road gritting. Carillion struggled to provide so many specialist services at once. Over time the risk of the company's failure became systemic, but it could have been avoided had the PSA been properly heeded.

The Carillion debacle has thrown the bidding process and the awarding of public contracts into the spotlight. Under the PSA, a company which was unsuccessful in the contract bidding process can challenge the decision of the local authority if they feel the contract was unfairly awarded, causing possible financial risk and undoubted business uncertainties for winning contractors.

The most common scenario is when company A is awarded a contract, company B disagrees and appeals, and ultimately the contract is awarded to company B. That leaves company A to pay out for goods already ordered, extra staff hired, and legal fees for the dispute. Court hearings delay the project enormously and, in some cases, the contract is re-tendered, pushing the project even further back, and forcing the original successful bidder to pay for second tender costs, too.

The consequences of an overturned decision are frustrating and potentially financially onerous for any temporary bid winner. For SME contractors and developers in particular, the problems caused could be crippling. They may not be able to afford the additional fees, will lose expected profit from the job, and they miss out on new contracts because of disrupted timelines.

Risk mitigation

However, many of these frustrations can be alleviated by introducing appropriate risk management protocols before bidding. A thorough risk assessment and a comprehensive indemnity insurance policy can be implemented quickly by a qualified internal risk manager or an expert external advisor. The risk assessment will reveal the potential losses that the bidder would incur if successful bids were overturned under the PSA. Insurance policies can then be procured to cover that range of losses, including legal fees, expenses incurred, potential lost profits, and bid costs for the second tender.

As a risk manager, the awarding of a contract should be a celebration, not a time to worry. But the consequences of an overturned decision should be duly considered and prepared for. Straightforward, sensible risk management steps allow lenders, purchasers and tenants to mitigate the risks associated with contract procurement in a timely, cost-effective fashion.

Anna Beadsmoore is head of legal indemnity at Gallagher