UK: Carillion And Commercial Contracts: What Can We Learn?

Last Updated: 18 January 2018
Article by Patrick McCallum

The fallout from the construction firm Carillion going into liquidation on 15 January continues to dominate the headlines in the business world. Workers face great uncertainty as to their futures, businesses that were reliant on Carillion for their work have been left with "black holes" of debt and large public sector projects such as HS2 are in jeopardy.

The full impact of this event remains to be seen; however, it is not too soon for other businesses to apply the case of Carillion to its own contracting practices, either as part of a supply chain or when looking to outsource services.

Customers taking matters into their own hands

Over the last few days, the government has faced a significant amount of pressure and scrutiny as to whether it should decide to bail out Carillion with tax payers' money. As a general rule, customers should always seek to ensure that in their outsourcing contracts they have a right to step in and take over a supplier's obligations in the event that the supplier commits a serious breach of contract. Step-in rights are commonly used where a supplier becomes insolvent and ceases to be able to continue to deliver the services it is required to provide under a contract. The customer will serve notice on the supplier that it intends to take on the obligations of the supplier or appoint a third party to do the same.

Whilst the wider implications of stepping in to the supplier's shoes will sometimes dictate that the customer elects not to exercise such rights, it is always best practice for the customer to have the option to step-in so that critical projects can be completed and disruption to the beneficiaries of the services can be kept to a minimum.

This is illustrated in the Carillion case where the government has chosen not to bail out Carillion but will provide funding to maintain the public services run by Carillion such as the maintenance of prisons, management of school buildings and provision of in-patient hospital beds.

Termination for insolvency

Some customers may see little value in continuing to work with an insolvent supplier who can no longer perform the services the customer needs to carry on its business. In such cases, customers may decide that the best course of action is to simply sever ties with the supplier and install a third party in its place. For this to happen, the customer needs to have a right to terminate the contract for the insolvency of the supplier. This is a standard provision in many supply agreements but it is important to ensure that the right to terminate is drafted widely enough to cover all the different ways in which a party could become "insolvent", including liquidation, administration, statutory insolvency and going into receivership.

Sub-contractors and retention of title

From a sub-contractor's perspective, it will also want a right to terminate its agreement with the prime contractor in the event that the prime contractor becomes insolvent. As above, sub-contractors will need to ensure that these termination rights are drafted widely but it will have other concerns that it will need to address in its contracts.

For example, the sub-contractor will want the ability to go onto the prime contractor's premises and recover any equipment and tools it may have left on-site. Similarly, the sub-contractor will want to be able to recover any goods which it has supplied to the prime contractor but which have not been paid for.

To help it in this endeavour, the sub-contractor should have retention of title provisions in its contracts which specify that:

  • title in goods does not transfer to the prime contractor until the goods have been paid for in full and in cleared funds;
  • until title does pass to the prime contractor, the prime contractor must:

    • store the goods on its premises separately from other goods;
    • not mix or combine the goods with third party goods so that the goods cannot be recovered by the sub-contractor;
    • clearly label the goods so that they can be identified as belonging to the sub-contractor;
    • it has the right to enter the prime contractor's premises to take such goods in the event the prime contractor becomes insolvent;
    • if the goods are resold by the prime contractor, the sub-contractor shall be able to assert rights in the proceeds of the sale in order to satisfy the purchase price of the goods.

Show me the money

Sub-contractors will also be keen to recover any outstanding fees from an insolvent prime contractor. There are already fears that a number of Carillion's suppliers could also become insolvent as they struggle to cope with the prospect that large invoices will never be paid and that significant costs in start-up activities and work in progress will never be recovered. Current commentary suggests that the Government will make sure sub-contractors on public sector projects are paid but suppliers on private sector contracts will become creditors of Carillion. This means that sub-contractors that have already waited for payment may now receive nothing for the work they have undertaken and this may impact the whole supply chain.

Wherever possible, debts should be secured and contracts should be drafted so as to reduce the risk of sub-contractors being left out of pocket in the event that someone higher up the supply chain goes bust. If sub-contractors are concerned about the risk of insolvency they could protect themselves by requiring payment up front or at least strict payment terms in the contract.

Conclusion

As stated above, the full impact of Carillion's insolvency remains to be seen, but it is almost inevitable that the effects of its insolvency will be significant and long lasting. With accusations being directed at the government that it has failed to manage its contracts effectively, perhaps the best thing that businesses can do is review their own contracts to ensure that they contain the necessary provisions to help protect them in case a "Carillion event" arises in any of their own supply chains.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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