Carillion’s Collapse and Why Bonding Matters
Tuesday, February 27, 2018
The collapse of the U.K. construction giant Carillion sent shockwaves throughout the global markets and prompted an immediate reminder that big contractors can fail. Insolvency experts predict a chain reaction is imminent for smaller construction firms to falter as a result of not receiving the payments owed. The Surety & Fidelity Association of America (SFAA) examines what reportedly went wrong with Carillion, what can we learn from this disaster and why it matters.
Carillion PLC was a multinational construction company and facilities management provider headquartered in the United Kingdom. It employed a staff of 43,000 individuals world¬wide and held approximately 450 governmental contracts across the U.K. ministries of education, justice, defense and transportation.
The company held operations in Canada, the Middle East and the Caribbean, and was a large construction services provider for the Canadian Government.
In 2016, Carillion enjoyed £5.2 billion ($7.3 billion) in sales and a market capitalization of nearly £1 billion ($1.4 billion). The trouble for the company began due to losing money on big contracts and running up massive amounts of debt to offset its losses. Industry analysts argue that Carillion overreached and took on too many risky and unprofitable contracts, while it reportedly faced payment delays from contracts in the Middle East, which have now been disputed. In 2017, Carillion issued three profit warnings within a span of about five months and had to write-off over £1 billion ($1.4 billion) from the value of some of its contracts. In January 2018, the construction giant folded under more than £1.5 billion ($2.1 billion) in outstanding debts, which left U.K. taxpayers, and as many as 30,000 subcontractors and suppliers to bear the cost of this insolvency. In Canada, four of Carillion’s companies were granted protection from creditors under the Companies’ Creditors Arrangement Act (CCAA).
The significance of this type of collapse creates a ripple effect throughout the construction industry. Approximately £1 billion ($1.4 billion) is owed to the various 30,000 subcontractors and suppliers. Profit margins in the construction industry typically are tight, so missing payments for work performed can be catastrophic for many small and medium size businesses (SMEs). Subcontractors and suppliers may believe the project owner ultimately is the guarantor of payment obligations owed, but without the proper safeguards, such as a high percentage surety bond, there is no enforceable right to payment for subcontractors and suppliers.
Construction is risky business. Research conducted by BizMiner between 2014 and 2016 indicates that 29.3% of contractors fail in the U.S. That is more than one in four construction companies. Most companies perform more than one job at a time. It is not uncommon that the loss that causes the collapse of a company is not the job being performed for a public entity, but one of its other projects. The Canadian Centre for Economic Analysis reported that non-bonded construction firms are ten-times more likely to suffer insolvency at any given point in time – making the current situation in the U.K. possible.
“Surety bonds protect – not only governments, taxpayers and workers, but private owners and lenders from unforeseen issues that arise during construction,” said SFAA President Lynn Schubert. “No other risk management product provides the comprehensive protection that bonds provide, which is to guarantee that a construction contract will be completed and subcontractors on the job will be paid.”
Compared to other risk mitigation tools, surety bonds provide additional benefits. A letter of credit, for example, may provide financial compensation to a state or local government if a contractor defaults, but in a small amount. It almost never accounts for 100 percent of the project costs. The biggest issue with using letters of credit or similar tools is that no one is responsible for completing the contract – or paying subcontractors and workers – in the case of default. By contrast, sureties enable the hiring of replacement contractors or re-rebidding of the contract and assume responsibility to save projects. Subcontractors can claim directly on the surety.
Sureties pay billions of dollars a year in claims. Over the last 15 years, surety companies paid nearly $12 billion to complete construction contracts and pay subcontractors and suppliers what they were owed. These numbers do not include the significant amount of money sureties spent to finance troubled contractors so they could complete contracts and avoid the trouble caused to owners and subcontractors by a default.
In the wake of the Carillion collapse, one thing is certain – the need for surety bonds from licensed surety companies remains. Had the British government and others required high percentage bonds on its projects, the contracts would be moving to get back on-track and qualified subcontractors would be paid. Surety bonds remain the smartest risk management tool for international governments, and U.S. federal, state and local leaders to protect taxpayer money.