As the fallout from the collapse of major government contractor Carillion became clear on Monday, Cabinet Office minister David Lidington defended the decision to award contracts to the company despite a series of profit warnings and other signs of deep financial problems. Lidington said that the government had continued to award contracts to Carillion because there are “rules on the type of information that you can take into account when taking those decisions.” This is true. But do the public procurement rules really require the government to award contracts to financially unstable companies? Top civil servant John Manzoni also referred directly to the EU procurement rules in his evidence to the Public Administration and Constitutional Affairs Committee on Carillion’s collapse – saying that these prohibited the government from excluding companies in its position.

There are many ways under the UK and EU procurement rules to evaluate the financial stability of a contractor, and to exclude them from bidding or end contracts where appropriate. This begins at the selection stage with the ability to assess financial and economic standing, continues through the bid evaluation stage with the obligation to identify and, in certain cases, reject abnormally low tenders, and includes an almost unlimited number of measures which can be taken at contract performance stage to ensure ongoing financial viability, and to enable termination or assignment of a contract where the contractor is in trouble or failing to deliver. I discuss these measures in more detail below. While the Carillion debacle cannot reasonably be blamed on the procurement rules, there appears to have been a failure to properly interpret and apply the relevant rules.

What went wrong

Carillion amassed £1.3 billion in debt through its rapid expansion and acquisition of other companies. While it continued to win private and public sector contracts, many of these were low-margin construction contracts and delays in delivery (such as at Liverpool’s Royal Hospital) led to serious cash flow problems. Carillion’s average margins, at 4.1%, were above many construction firms and it had also diversified into various service contracts, such as providing prison and hospital meals and buildings maintenance, including at GCHQ. Nevertheless, the strategy of piling numerous low profit contracts upon each other was a high risk one.

It seems the government adopted a strategy of hoping that Carillion could trade its way out of trouble, not an entirely unreasonable idea (Serco did something similar, although by adopting a different strategy), but riskier than extricating itself from troubled contracts and excluding Carillion from bids once its problems became clear. Contracts awarded after Carillion began issuing profit warnings in July 2017 can be seen as bailouts-by-other-means – an attempt to help Carillion maintain its cashflow despite its problems. It’s possible however that the government was genuinely under the impression that it could not legally exclude Carillion despite clear evidence of its financial instability.

Can a company be excluded if it has issued a profit warning?

The EU public procurement rules allow a company’s economic and financial standing to be evaluated at the selection stage, and provide a non-exhaustive list of considerations which can be taken into account. The Court of Justice has upheld the use of various indicators in this regard, including a requirement that bidding companies demonstrate successive periods of profitable operation.[1]

Public bodies can also require that performance guarantees be issued by financial institutions at selection stage.[2] Financial selection criteria should be tailored to the particular sector and the particular contract, rather than adopting a ‘one size fits all’ approach. Of equal importance to the choice of criteria is the ability to meaningfully assess the information submitted by bidders, seek clarifications where needed and to decide when a bidder should be excluded. While many contractors will seek to challenge an exclusion decision, provided the rules are clear and proportionate to the size and nature of the contract, such challenges are unlikely to succeed.

Beyond assessment of economic and financial standing, there are two exclusion grounds which may be relevant in cases where a company is carrying large amounts of debt. The first applies if the company has not kept up with tax or social security (including pension) payments.[3] The second applies where a company withholds or seriously misrepresents any information relevant to its exclusion or selection (i.e. including information on financial matters), or where it fails to submit appropriate supporting documents. What if a profit warning or other evidence of problems appears after the qualification stage? The 2014 directives and 2015 Public Contracts Regulations are very clear that a company may be excluded at any point in a procedure where one of the grounds is found to apply.[4]

Both Lidington and Manzoni pointed out that the major contracts awarded to Carillion (including HS2) after July 2017 were those in which it served as part of a joint venture or consortium. Does this change the situation regarding selection and exclusion? Again, the procurement rules are very clear that when a bidding company relies on other entities (whether as part of a consortium or otherwise) for the purposes of qualifying for a bid, the exclusion and selection criteria must also be applied to that entity.[5] Where a partner on whom a consortium seeks to rely for the purposes of qualification lacks the relevant financial or other capacity, or subsequently loses it, a public client can require that partner to be replaced.[6]

If a contractor does manage to satisfy a contracting authority of its financial stability and proceeds to the bid stage, there is still a need to evaluate the financial viability of the bid itself. The rules on abnormally low tenders require that these be investigated, with bidders being given an opportunity to explain any pricing which appears to be unsustainable. It is ultimately up to the contracting authority to decide whether such explanations are convincing or whether a real risk of non-performance or other problems remains. Where a tender is abnormally low due to a company not complying with environmental or social laws (including pension regulations and any applicable wage agreements), then it is mandatory to exclude that bid.[7]

It’s possible that an even earlier sign of Carillion’s instability could have been acted upon by the government. According to reports in the Financial Times, hedge funds began to bet against Carillion as early as 2013 on the basis that it was taking 120 days to pay some subcontractors. The 2015 Public Contracts Regulations require contracting authorities to pay undisputed invoices within 30 days, and also require contractors to apply these same payment terms to subcontractors. Any robust public sector contract awarded since 2015 should include sanctions for contractors not applying such terms in their contracts – which it seems Carillion was not.

Sharing information between departments

One factor which seems to inhibit government departments (as well as the wider public sector) from applying selection and exclusion rules robustly is the fear that other authorities will take a different approach. This is not necessarily a bad thing – as mentioned the assessment of financial capacity should be specific to each contract and a company may be perfectly capable of performing a smaller or lower-risk contract. Companies which have been excluded from bidding on one contract should not fear being ‘blacklisted’ by the public sector as a whole; as their financial situation changes fresh assessments should be made. However given that much financial information is not in the public domain, there is some value to having common sources of information about major government contractors. In Germany, this is being addressed by development of a shared register containing information about suppliers relevant to exclusion and selection criteria. In the UK, Crown Commercial Representatives are intended to fulfil this role in a different way – however it appears this system broke down in Carillion’s case.

Contract management measures

The procurement rules have always left public bodies a wide discretion to define their contract terms. Where concerns exist about the financial stability of a company, special terms may be added to provide government with early warning of this and to take appropriate measures to minimise the risk to public services. Undoubtedly some of these terms exist in the Carillion contracts, but there is a question as to why they were not activated earlier, potentially averting the major scale of intervention which must now be taken – placing considerable stress on government resources. Again this seems perhaps to have been driven by an excessively sanguine view of Carillion’s capacity to trade out of its difficulties. It may also reflect a reluctance to activate terms which could ‘spook’ the market, thus hastening a company’s collapse. Like selection and exclusion criteria, contract terms should reflect size and risk, and provide for a range of interventions which may be appropriate for situations of varying gravity.

An in-house solution?

Other contractors are hovering over the carrion of Carillion’s contracts, ready to pick up any viable business. While it’s vital that we understand what went wrong with Carillion, those who seek to question all forms of outsourcing based on its collapse are surely off-mark. The public sector cannot and should not directly provide all of the goods, services and works which citizens expect it to deliver – that would limit both the quality and quantity of public services while undermining competitive markets. Given the number of prominent failures in outsourced contracts, it is understandable that questions are asked about the overall benefits of outsourcing. But just as the ‘market is always better’ ideology has failed to deliver on many occasions, the ‘public sector is always better’ ideology is likely to fall short.

There is no obligation under the EU procurement rules for a public body to award a contract for any service if it doesn’t wish to. In-house bids can be considered either in advance or as part of competitive procurement procedures, meaning that if the public sector is in a better position to deliver a particular service directly, it should do so. Naturally private contractors are not always keen on this approach, but they have also failed to challenge it successfully.[8] Alernatively, authorities may decide to award a contract to a connected public body without any competition, provided certain conditions are met, in particular that this doesn’t end up conveying an advantage on any private operator.[9]

Conclusion

Before retreating to ideological ghettos in which the private sector is either always right or always wrong, it’s worth asking whether things could have been done differently under the existing procurement rules. These rules seek to balance the idea of fair competition with the right of the public sector to choose who it wishes to contract with, and allow government to include a wide range of economic, environmental and social considerations in these decisions.

This article has identified five separate grounds on which companies in a similar situation to Carillion may either be excluded from bidding for public contracts, have their bids rejected or have contracts terminated under the current EU and UK procurement rules:

• Poor financial and economic standing at the time of bidding or any other point up to contract award;

• Failure to make pension contributions or pay taxes or national insurance;

• Misrepresentation or failure to disclose any information related to the above grounds;

• Submission of an abnormally low tender;

• Failure to pay subcontractors within 30 days or breach of any other contractual term related to good financial management or proper delivery of services.

It is therefore grossly misleading to suggest that the procurement rules required the government to continue awarding contracts to Carillion after its financial difficulties became clear. The true reasons for the government’s actions probably relate more to the extent of Carillion’s public sector business, including a number of high profile contracts, and the mistaken belief that it could trade out of its difficulties. While hindsight is a wonderful thing, Carillion may be a canary in the coalmine for poor procurement and contract management practices which extend to other major government contractors who find themselves in similar financial holes.

[1] In case C-218/11 Édukövízig and Hochtief Solutions[2] Case C-76/16 Ingsteel and Metrostav[3] Art. 57.2 Directive 2014/14/EU; Reg. 57(3) and (4) PCR 2015[4] Art. 57.5 Directive 2014/14/EU; Reg. 57(9) and (10) PCR 2015[5] Art. 63.1 Directive 2014/24/EU; Reg. 63(4) PCR 2015[6] Ibid, see also Case C-223/16 Casertana Costruzioni Srl v Ministero delle Infrastrutture e dei Trasporti [7] Art. 69.3 Directive 2014/14/EU; Reg. 69(5) PCR 2015[8] See Montpellier Estates v Leeds City Council [2013] EWHC 166 (QB)[9] These conditions are set out in Regulation 12 of the PCR 2015.