Carillion

Stephen Kerr Excerpts

Thursday 12th July 2018 Commons Chamber

[Rachel Reeves (Leeds West) (Lab)]

I beg to move,

That this House has considered lessons from the collapse of Carillion.

I am grateful to the Backbench Business Committee for scheduling the debate for today, which is timely. This Sunday it will be six months since Carillion entered liquidation. When it collapsed, it employed 42,000 people, more than 19,000 of them working in the United Kingdom. It held liabilities of £7 billion, including a £2 billion liability to 30,000 suppliers and subcontractors, and it held just £29 million in cash to meet those liabilities. In the past six months, nearly 2,500 Carillion workers have been made redundant and more than 1,000 have voluntarily left what remains of the business. Projects have been mothballed and suppliers have faced ruin.

Since the collapse of Carillion, five Committees have looked into the issues surrounding its collapse. Along with the Work and Pensions Committee, my Committee—the Business, Energy and Industrial Strategy Committee—has considered the causes of the collapse. The debate is also timely because this morning our Committees published a special joint report containing 24 responses to our original report. It gave those criticised in the report, and those with a significant interest, a chance to respond ahead of the Government’s formal response to our findings. In the time that I have this afternoon, I shall set out what my Committee found, and what needs to change. I thank fellow members of the Joint Committee, some of whom are in the Chamber today, for their work to uncover the lessons from Carillion.

When it collapsed, Carillion had been in existence for 19 years. It was the second largest construction company in the UK, having grown through large and frequent acquisitions and Government outsourcing. Carillion’s directors, and those who know the construction industry, told us that it was a low-margin industry, and part of a highly competitive market with inherent risks. Businesses do collapse every day, and the process of business creation and failure is part of any well-functioning modern economy, but warning lights should have been flashing when such a big business was on the brink. We should demand the highest standards of corporate governance to help to ensure that British businesses are well run, but that did not happen with Carillion.

Despite its catastrophic failure, the Carillion directors, when they sat in front of our Committee, continually claimed that the business was sound, even after it had gone into liquidation, and that only a handful of contracts had brought it down. They even said that everything was fine until just a few months before the collapse. As late as the day before Carillion went into liquidation, the directors thought that they could avert the collapse. They seemed to have a sense of entitlement, and a belief that the Government would step in and bail out their failed business. In their evidence to us, they blamed everyone but themselves. They blamed the Bank of England, the Canadian construction market, Carillion’s suppliers, and professional designers of concrete beams.

However, the collapse of Carillion has meant that our Committees have been able to see the board papers and minutes from company meetings, many of which we have published. Looking inside the company, we have seen a business that acquired other businesses, and relied on unrecoverable “goodwill” to prop up its balance sheet; a company that kept increasing senior salaries and bonuses, and ensured that a dividend was paid regardless of its own health; a company that was paying suppliers late, and bidding for contracts that it could not afford to deliver on time or on budget.

Carillion’s largest acquisitions—of companies such as Mowlem, Alfred McAlpine and Eaga—allowed it to put “goodwill” on its balance sheet. Those notional values of each acquisition, totalling almost £1.5 billion, were allowed to sit on the balance sheet for year after year, without any link to reality and the real value. When the company collapsed, the goodwill was wiped out, too, showing its true value—a value of zero. Carillion’s board needed healthy balance sheets to continue its dividend policy of increasing its payout to shareholders, but the truth is that it paid those dividends regardless of whether it had the cash flow required for them. Right up to the spring of 2017, it was promoting its growing payout with little challenge—no challenge—from directors as to whether the money might have been better spent supporting the pension fund, for example, or any part of the failing business.

Despite the growing pensions deficit, there is one area where directors felt able to spend money, and that was on growing salaries for the leaders of the business. Its remuneration committee increased payouts on the basis of industry averages, rather than the performance of the business Carillion. A responsible business would see payment by results, not payment by averages.

When Carillion’s directors needed to prop up their balance sheets, they did so by putting pressure on the suppliers. Carillion was, ironically, a signatory to the Government’s prompt payment code, promising suppliers they would be paid within 60 days. When the code was launched in 2013, Carillion was already known to Government as being poor payers, but the National Audit Office report into the company showed that in signing it up to support the policy the Government seemed to turn a blind-eye to Carillion’s failure to meet its duties to suppliers.

We heard on our Committee from the Federation of Small Businesses that some businesses were waiting more than 120 days for payment and Carillion had become notorious as late payers. Carillion managed to use this to its advantage, arranging an early payment facility with the banks, meaning suppliers could receive payments earlier than Carillion’s 120-day terms but they would have to face a cut in what they were owed in order to do so. Carillion was effectively borrowing from its suppliers, propping up its balance sheets again without a care for the state of the balance sheets of the thousands of businesses relying on it and doing its work.

[Stephen Kerr (Stirling) (Con)]

rose—

[Rachel Reeves]

I give way to my fellow Committee member.

[Stephen Kerr]

The hon. Lady is making a powerful case for what we found in the inquiry. As evidence of this house of cards that she is describing, which it undoubtedly was, Richard Adam, the former finance director, told the inquiry that not only did he sell all his shares when he left the business, but he would not be prepared to put his own money at risk by being a shareholder.

[Rachel Reeves]

I absolutely agree. The directors of the business were not invested in the business. They were not part of the pension fund that collapsed and, as the hon. Gentleman said, Richard Adam, the finance director who oversaw the accounting practices that helped to contribute to the collapse of the company, sold his shares as soon as he could because he knew what we all now know: this business was a failing business that would not be around for much longer.

What we found in Carillion was a board focused on short-term fixes and growing payouts, with no plan for what would happen when the illusion was shattered. Looking at the poor treatment of suppliers when the company was solvent and the trail of destruction the management of the company has caused, I cannot see how Carillion’s directors can make any claim that they had anything other than their own personal interests at heart. In the latest responses that we have published today, Carillion’s directors continue to refuse to demonstrate any culpability for the state the company was in. They have denied that our report is accurate, but have given no evidence whatsoever to support their case.

Let me be clear: the directors of Carillion are culpable for the company’s collapse. They should be ashamed of their performance and they should not be allowed to take the helm of a company ever again.

--- Later in debate ---

[Sir Bernard Jenkin]

I totally agree with the concept that these contracts become too big to fail, and therefore, as I will explain, it becomes an illusion that the Government have transferred risk to these companies. These companies are a private sector extension of the public sector, and the public sector still carries the risk.

[Stephen Kerr (Stirling) (Con)]

My hon. Friend spoke earlier of contracts basically being awarded on price, rather than on any kind of value. Does he agree with the CBI’s response to the Carillion report that suppliers to the public sector need to “bid responsibly” for contracts and need to be “prepared to challenge” bad deals and to “walk away” from opportunities that will not yield long-term value? The reality is we have a group of companies in this country that seem to be addicted to bidding on price, and this becomes a self-fulfilling prophecy, à la Carillion.

[Sir Bernard Jenkin]

I agree, but unfortunately I think that the Government have fed that addiction. The pressures of austerity and the hunt for savings have encouraged the Government to try to get prices down and to be blind to the risks they are transferring to the private sector, resulting in the sickness of the sector. As I will explain, there is a misappreciation of the risks that private shareholders are prepared to bear, compared with the risks that we should be taking with public services and public money.

As I have said, the Government sometimes write into contracts that companies must accept the risk that the Government have got their own data wrong. An analysis disclosed by Serco found that this practice had taken place in 12 of the company’s recent procurements. That is in part driven by the decision to use contractual models such as payment by results that involve risk transfer on a huge scale. If the Government cannot assess the services they are trying to outsource, they simply cannot make an accurate calculation of a fair cost for the outsourcers, yet they tend to pretend to do so. In those circumstances, passing the risk on to contractors is unacceptable and, as we have seen, proves counterproductive, particularly if the Government are unable or unwilling to make a serious assessment of what is at risk when a company delivers public services.

PACAC found that the relentless drive to bring down costs has been among the most damaging factors. We received evidence from organisations and businesses in the sector that the Government have been “driven by price exclusively”, leading to a reduction in fees paid by up to 25% to 30%. Some people put it more bluntly. Rupert Soames, the chief executive officer of Serco, told us that

“in the four and half years that I have been running Serco I know one occasion”

when Serco had won a contract despite not being the lowest bidder. A survey conducted by the CBI revealed that 98% of businesses responding said that something other than “service quality” was the main reason why Government contracts are awarded. There are obvious problems with an undue reliance on price in the contracting process; industry leaders were concerned that “fudges” would

“allow technically poor but cheap bidders to continue... simply because the customer is desperate for the saving.”

Such bidders would then seek to renegotiate the price afterwards.

There are examples of all this going badly wrong. The Government, who are frequently the dominant purchaser in these markets, have great power to dictate prices to contractors. Professor Gary Sturgess, of the Australia and New Zealand School of Government—and why did we abolish our National School of Government and so have no equivalent institution?—told PACAC that companies were

“stupid to have gone ahead and entered into contracts... but this is a Government supply chain. ”

Representatives from the National Council for Voluntary Organisations said that, on average,

“large charities lose 11% on each contract they have with the government.”

There is something rather unpleasant about Government milking charities to subsidise public services, but that is, in effect, what is happening.

Instead of recognising that the focus on cost damages the ability of companies to meet the terms of their contracts and discourages innovation, the Government have taken a different approach. In some instances, they forgo performance penalties available to them, in essence declining to enforce the parts of the outsourcing contract that are designed to maintain the high standards of the service being provided, at the agreed price. In others, the Government have renegotiated the terms of some contracts. We received evidence from the Cabinet Office that just since 2016 the Government have renegotiated at least £120 million-worth of contracts in that way, including the Ministry of Justice’s flagship “Transforming Rehabilitation” scheme. The cost to the Government of the work necessary for the renegotiation itself is yet unknown.

PACAC found that the Government do not have a strong evidence base about when and whether to use the private sector, or whether such use will be more successful than using the public sector. This is what we call the decision to make or buy. The Treasury Green Book sets out a process that should be gone through when deciding whether to make or buy a service—whether to do it in house or put it out to contract—but we found no evidence that that was well understood or indeed followed. There is also a lack of a central database for outsourcing contracts, meaning that systematic analysis of outsourcing throughout the whole of Government is difficult at best, if not impossible. Nowhere is there an understanding of how much public service risk is being carried by each company, across all of its contracts and across all Departments. Without that kind of understanding, the Government are unable to prove the basic premise behind all forms of Government outsourcing: that the private sector is capable of providing a better service for better value. The basis for the claims made by the Minister who wrote the article in The Times earlier this week is data that is now some 20 years out of date. All this data should be published, as public confidence will not be strengthened without far more openness and transparency about how public contracts are let and managed. Nowhere is that more apparent than with private finance initiatives.

The ostensible purpose of PFIs was to take advantage of the expertise of the private sector in providing privately-financed infrastructure projects and buildings. However, despite having more than 20 years to research and form an evidence base, the Government were unable to justify their claims about the efficacy of PFI. In fact, in their testimony to PACAC, the Government claimed that PFI brought “discipline and rigour” to projects. But, while giving evidence, the chief executive of the civil service revealed that the real purpose is to make the public balance sheet look better. That motive can also be seen in the refinancing provisions for PFI, which allow the balance sheet to look better at the expense of the public finances.

It gets even worse than that. With private finance 2, it was decided that the proceeds of refinancing PFIs should be split between the contractors and the Government. After a school has been built and it is in the process of being managed, a lot of the risk has been carried, so the scheme can be refinanced at a lower rate of interest. It was decided that the benefits of that lower interest rate should be split 50:50 between the Government and the private sector. That was not the case with the original PFI scheme. It subsequently became apparent that, under the rather arcane public accounting rules, if such a change is made, the whole of the debt becomes public sector debt and is shown in the public sector borrowing requirement, so the Government said, “Oh, well, we’ll split it 70:30”. Therefore the Government now collect only 30% of the proceeds from refinancing a PFI contract. That is daft. It is the Government giving away public money just to satisfy silly public accounting rules. It should stop.

There are also issues concerning churn among civil service staff that make the management of public contracts difficult. Reports have highlighted the “insufficient continuity of staff” over the lifetime of a contract. On this front, the situation has been improving, but there is a great deal to do.

PACAC remains concerned that the Government are still taking a much too transactional approach to contracting and the management of contracts. It is vital not only that staff with commercial skills work alongside those within Government with other skills such as costing, IT and project management, but that those in the Government who manage the contract feel that those in the private sector are partners and collaborators. There should be trust and co-operation; it should not be an adversarial competition. When the Government make the decision to outsource a service, and when they accept bids from companies seeking to win the contracts for those services, it is crucial that the process of doing so is evidence-based and transparent.

It was to ensure that there was public trust in outsourcing, and in the Government’s capacity to do so, that Carillion was awarded contracts after it published a profit warning and after it had made other worrying sounds to the Government. That a company in the process of going bust should be awarded yet more contracts, giving it access to yet more taxpayer money, does raises the questions brought up by the hon. Member for Inverclyde (Ronnie Cowan) earlier. PACAC calls for the Government to re-examine how they assess contractors’ viability. Shareholders are prepared to take a far higher risk than the risk the Government should be prepared to take with public services and public money. The Government should publish their rationale for their decisions. Public service procurement cannot be done in the dark, cannot be done without evidence and cannot be done without the Government knowing what they are trying to outsource. It cannot be done on the cheap, and the public must be able to see that.

In conclusion, unless the right steps are taken and the right lessons are learned, a company very similar to Carillion, holding contracts of enormous public worth, could collapse again and all this will happen again. The public want companies that deliver public services better to reflect public-service values. Such companies are part of the public service, and if they do not demonstrate those values, they should not get the money.