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February 28, 2018updated 25 Jan 2022 12:20pm

Carillion executives’ testimony demonstrates inability to prioritise equity over debt

By Brian Cantwell

Through a parliamentary inquiry into the collapse of Carillion, it became clear that overuse of debt over equity helped bring the construction giant down. Brian Cantwell takes a closer look, with additional reporting by Lorenzo Migliorato.

On Tuesday 6 February 2018, the Business, Energy and Industrial Strategy Committee and Work and Pensions Committee interviewed Carillion executives and board members on the giant’s collapse.

After MPs told the interviewed board that the official receiver said it was unable to get “a full picture” of Carillion’s finances, it became clear that in the period 2011 to 2018, a growing reliance on a £500m reverse factoring facility provided by RBS, Barclays, HSBC, Lloyds and Santander UK was a primary cause for concern.

By July 2017, Carillion had put its use of the reverse factoring facility, which it called the Early Payment Facility (EPF), at £412m. The gap the facility was intended to fill was only creating worse problems for the business’s balance sheet.

The EPF was introduced to allow Carillion to pay contractors within the UK government’s four-to-five-day target.

Carillion chief financial officer Emma Mercer told the committee: “The drive to get receivables back from those businesses was the key to removing pressure from the cash flow.

“Drawdown for suppliers was within four to five days, but we got the benefit of the working capital up to 125 days.”

Yet Carillion itself was not being paid for 125 days, and longer.

“The reason we introduced it is because we went back to the government’s prompt payment code and our other customers. We were being pushed to pay within four to five days, but we were not being paid within four to five days,” said Mercer.

The difference in the balance of payments pushed the business further into debt, and did not match with the increasing risks associated with variable and stretched contracted payment dates. It was a system that led Financial Times journalist Matthew Vincent to describe it as a “lawful sort of Ponzi scheme”.

Cash flow

A crucial point for the business and its lenders was the cash-flow projections on which the covenants of the EPF facility were based.

Chief executive officer Keith Cochrane said revealingly to MPs: “If I can add a bit of hindsight as CEO, then there was a lot of focus on reported debt across the business. But was there the same focus on collecting cash day in, day out? Did that appear to be the case before 10 July 2016? No.”

Later, he added; “It was not obvious that we were insolvent due to cash forecasts: the problems were linked to contracts, to the business structure. It was not clear in my mind when I took over on 10 July that we would end up in insolvency.”

Zafar Khan, removed as chief financial officer of Carillion in September 2017, was let go after he presented revised cash-flow projections, only a few months after presenting cash-flow projections to the board.

Asked why he was removed from his position, Khan said: “Post the July trading updates, we had committed to a range of initiatives to prove the position of the business. Chief within this was the initiative to improve the cash flow, also delivering the revised forecast.

“As we went through July and August, trading conditions did not really improve much and things started to get difficult for us.”

Asked whether that was going to be improved by sacking him, he replied: “That is a board decision and not really for me to debate. I had provided the board with a further update in September, and not long after that I was asked to step down from the board,” said Khan.

“It was a very short conversation that I had with Cochrane, and then during the conversation I was told that the update I had provided to had spooked the board, and that certain lenders were unhappy.”

The revision of the cash-flow projections in September 2017 had been unpalatable to the board most likely because the projections were downgraded and the business was unlikely to be able to meet the covenants of the EPF reverse factoring facility, and its other debts to its lenders.

In essence, Carillion had ignored its debt-to-equity ratio and had become unable to meet covenants set by its banking partners. Through a neglect of debt management and a failure to bring debts down, the board had indirectly made the invoice finance lenders the decision makers.

Questions remain as to whether it was a case of fault on the previous CFO, Khan, for overly bullish cash flow figures and then a radical revision in September 2017, or whether there was an attempt by the board to suppress the cash-flow figures so as not to “spook” the EPF lenders.

Later, Carillion chair Philip Green said the Carillion board had top advisers but that the cash-flow projections, used to secure the debt facilities and manage the business’s spending, had been revised unexpectedly.

Green said: “I believe that the board were well informed financially and were advised by a high-quality set of advisers. One of the reasons that Mr Cochrane was surprised was because the numbers that were presented on that occasion were different to those presented before.”

When asked how they were different, whether they were more aggressive, and whether the cash-flow projections showed this, Green replied: “The contracts in the middle period of last year were deteriorating, and the numbers varied dramatically.

“We believed the profit and the cash forecast reflected management’s best view at that time. We were all surprised by the extent and speed of deterioration between the spring and autumn of last year.”

Debt attitudes

In focus at the session was the reliance on debt, or goodwill, which hit 84% of the total balance sheet by July 2016. In December 2009, the business ran debts of £242m, but by January 2018 this figure was over £1bn.

MPs asked Cochrane what debt attitudes were like at the business. He answered: “The company felt that it had got to the position… clearly a lot happened in that time that drove what happened in the past months. The debt was too high by 2016, and the board had mandated management to come up with a solution. It was believed at that time to have launched a fundraiser which would have substantially lowered debt in early July.”

Khan added that the debt had become too large, but seemed unable to answer why it had not been brought down. “To my mind, one of the issues that contributed to where we ended up was the fact that our debt had grown over the past few years. That – combined with the number of challenges we faced, with four large contracts underperforming significantly in the market – and the market for support services got very difficult.”

Khan said that the business had failed to act on its debt burden effectively, in light of irregular payments it was receiving and contracts spiralling beyond their due dates, and there had been disagreements over payments to shareholders at a point where the business had rapidly accelerating debt heading for £1bn.

“I believe that I did everything that I could have done, essentially. Debt aside, we wanted to reduce that. There was a long debate about the dividend, before that passed,” said Khan. “We had a long-established policy of paying out a dividend on earnings growth, and our earning had gone up by 1.8% the prior year, and as a result the dividend went up by 0.8%.”

MPs pointed out that the valuation was based mainly on goodwill lending to the company. Carillion issued a dividend on 8 June, and then went on to issue a profit warning on 9 July, and gained new contracts on 17 July. MPs accused the board of manipulating the debt warning at that time, and suggested that the warning should have been issued sooner.

In response, Khan said: “In my mind there was not any manipulation to issue that soon – it had been done to different timelines.”


MPs also attacked the business for its accounting accuracy and practices, which included the way that receivables were logged, especially with a £200m Qatari contract that had been delayed.

Cochrane said: “We incurred the cost and we recognised the receivable associated with it – not 100% of it as there will always be a debate around these things, but from a cash point of view.

“If you look at the bulk of the provision, we recognised it was non-cash, because the cash had been spent already; it was all about how quickly we could collect the cash.

“Sure, the business made mistakes; the business did not do things as efficiently as they had assumed in the bid. Take the Qatar job: it doubled in size and had 2,500 design variations to it, and we were not paid for 18 months prior to the business failing. Should we have done something differently? [It] is a fair question maybe, but…”

MPs asked why work continued without payments, to which Cochrane answered: “Again, in terms of the specifics, one of the roles of the previous CEOs was to have more engagement with the customers.

“I do recall an April 2017 board meeting in Manchester when [ex-CEO] Richard Howson came back [from Qatar] and said they have agreed that they are going to pay all their bills.”

Then the Brexit referendum result returned, and expectations changed.

Cochrane continued: “There was this expectation that they were going to get paid, but then six weeks later the world had changed in a number of different ways. It was a judgement call.

“I looked at that contract and I looked to achieve a settlement; we had the ups and downs of those negotiations ultimately failing. But the fact was there was a substantial change in scope of the contract, so ultimately there was some effect to Carillion.”


In a general sense, there was a lot going on that was wrong at Carillion, despite the protestations that management followed procedures at the highest levels.

Leasing Life understands from one source who previously worked for one of the company’s lenders, and who wished to remain anonymous, that it was known that Carillion was “in trouble” among lending banks by 2015.

Poor corporate governance, an over-reliance on debt, aggressive accounting allegations and ineffectual decision-making were all to blame. The board signed off on a dividend payment valued on a company largely in debt in 2017, rather than paying off its mounting pension liabilities and reverse factoring debts, among others.

Throughout the hearing, fingers were pointed at different eras and decisions made. Chair Philip Green, who looked shell-shocked, admitted responsibility but not culpability.

Green put the collapse down to three factors: Firstly, Carillion grew too big and took on too much with its acquisitions, up to £300m by early 2011; secondly, a small number of large-value contracts went very badly wrong, including the £200m Qatar contract; and thirdly, it was unable to secure short-term financing in January, although in reality, by that point, Carillion had become close to a Ponzi scheme, given that its debt load was increasing exponentially.

UK SME leasing

The interplay over cash flow and debt financing is relevant for UK plc financing as the leasing market looks to SMEs to drive growth in asset finance, as well as larger businesses.

A properly used reverse factoring, or invoice finance, facility is an excellent way to protect working capital, given good governance, a reliable balance sheet and regular incomings for work done. But lessors should be aware, as in the case of Carillion, about SME businesses reliant on the supply-chain.

A £225m support fund has been set up by UK lenders for the thousands of SMEs affected by Carillion’s collapse.

Whereas plenty of SME businesses will be consumer-facing, there are thousands of UK SMEs that supply large businesses like Carillion and that are at risk if large corporates go to the wall. If larger corporates suffer difficulties in trading, then it is likely that SMEs will suffer difficulties too.

Many of those SMEs, and indeed the alternative finance lessors, were quick to say that the Brexit referendum had not affected their trading in 2016 or 2017. But as the Carillion committee inquiry found, UK businesses can have difficulties when eliciting payments for work done abroad, especially in relationship-driven-contract territories such as the Middle East.

The globalised yet-to-be arranged trade agreements proposed by hard-Brexit backbenchers, where Brexit Britain would work on the World Trade Organisation’s (WTO) rules, do not help clarify what to do in cases of late payments.

According to the WTO, the average time for a dispute to be cleared is roughly one year, while some disputes from 1995 have still not been resolved.

Perhaps pursuing late payments through the courts in the UK would secure a judgment, but enforcement remains a problem. And pursuing dispute resolution and legal recourse to problematically late payments – often 18 months for Carillion – would likely kill any repeat business.

Lessors may be able to recover value if an SME defaults on an asset, but there will still be losses to account for on behalf of SMEs if a large multi-function corporate fails.

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