I’ve decided to create a 3-part series on Carillion and the hidden goings-on in the accounting world. This is part 1, where I look at the insolvency process. You can read Part 2, on Carillion’s accounting here. You can read Part 3, on the ongoing investigations and aftermath here.
Sex sells. And at the moment, so does laying into accountants. I can’t open the FT or The Times without seeing an article criticising the accountancy profession. Just like banker bashing around 10 years ago, it’s the ‘in’ thing. It’s what the cool kids are doing.
There’s a lot of truth in what’s written. There’s also a lot of hyperbole. There’s also a lot of stuff that is downright wrong.
In particular about insolvency.
In the aftermath of Carillion, I’ve seen people claim there is no insolvency regulation – not true. That secured creditors get paid before the costs of winding up – wrong. Imagined conflicts of interest. And most bizarrely of all, complete ignorance of the involvement of the High Court in insolvency proceedings.
There are problems with insolvency, but these are lost among some of the ‘fake news’ put out there.
How do I know this?
I’m a Chartered Accountant. Not one of those ‘useless’ auditors or ‘thieving’ insolvency practitioners (who don’t have to be accountants by the way). I’m a forensic accountant, the guy you call when the shit has really hit the fan.
I’ve no love for auditors. My heart would sink when my colleague would say: “the X plc audit team needs a hand”. Likewise, when a restructuring came up I’d try to hide lest I get dropped in an alphabet spaghetti of accountancy chaos.
That’s why I’m writing this post. Because I’ve seen first hand what happens in insolvency, and it isn’t like what’s reported in the MSM.
Insolvency and Carillion
Over the past few weeks, I’ve been particularly irked by some of the stuff written on the Carillion insolvency.
So I’m going to run through the Carillion insolvency process.
First off, this is a liquidation (wind-up by the Court). There are four types of insolvency process: CVA, administration, liquidation and receivership. Each is different, each has several different sub-types. But I’m not going to talk about them (at least not today).
What is happening with Carillion
Carillion went bust. It couldn’t pay its debts. At that point, it stopped trading and went to the High Court asking to be liquidated. The High Court heard the petition and said, yes, you should be wound up.
The Court then went off to the Government’s Insolvency Service (IS), asking them to nominate someone to take charge of the liquidation. That person is the Official Receiver (OR). They are a civil servant, salaried by the Government.
The Official Receiver
The OR asks the Court if they are fine with them being in charge. Hopefully, they say yes.
The ORs job is to oversee the liquidation process. They are ultimately responsible. They must ensure an orderly wind up, try to get as much money for the creditors as possible and investigate what went wrong.
The ORs first job is to work out if they need help. That is, whether they need to get an Insolvency Practitioner(s) (IP) to aid them with the liquidation.
The Special Manager
In the case of Carillion, the largest ever UK liquidation, the OR clearly needed a lot of help. So he opened a process to find and select a suitable helper called a ‘Special Manager’ (SM). There are rules about when the OR can do this and he had to ask the Secretary of State for approval.
The OR negotiates with the possible IPs to find the best one for the job. With Carillion, the OR selected PWC (a firm with a very good restructuring team and having managed on the previous largest-ever insolvency). [p.s. I worked for two of PWC’s competitors so I’m by no means a fan.]
Together, the OR and PWC would have sat down to agree to fees and a plan. They would have gone through this plan with the largest creditors, the Pension Protection Fund (PPF) and the Government. When everyone was happy, the OR then asked the Court to approve the appointment of PWC (including their fees and the general action plan).
Now the real work begins. PWC’s principal role in the first week is to stabilise the company. Carillion would have been in carnage. They would have taken over operations with three major aims: protect the companies’ assets, save people’s jobs and get the company working again.
Once things have stabilised the OR and PWC will start working through their plan. Generally, this is:
- Work out what assets can be sold and for how much;
- Work out what onerous contracts can be escaped from; and
- Gather evidence to investigate any wrongdoing.
Let’s look at each of these for Carillion.
PWC will find Carillion’s most valuable assets and try to realise them. It’s a tricky process where good IPs come into their own. On the one hand, the liquidator wants to get as much money as possible. On the other, every day that passes means the costs rack up. It’s about finding the right balance, some of the top IPs are the quintessential wheeler dealers – making money that nobody thought was there.
To make sure the creditors aren’t being screwed, Real Estate experts, asset valuers and business valuers (like me) carry out independent valuations of major assets. The OR will oversee this and check they are happy with what the IP is doing.
Carillion was losing money for a reason. It had entered some bad deals. PWC and the OR will be looking to get out of the very worst ones. They will negotiate fee reductions, scope reductions or simply get out (sometimes through litigation). In many cases, Carillion worked in partnerships. PWC would look for the partners to take on work as quickly as possible to save costs.
The OR will be looking for wrongdoing at Carillion including Fraud, Fraudulent Trading and Wrongful Trading. If they find evidence, they will ask the Insolvency Service to bring action. This is the most difficult part of the job and requires lots of specialist skills (I’m biased as a forensic accountant, little-known fact: forensic accountants are the smartest and best-looking accountants).
The OR will ask forensic accountants to pore over Carillion’s books and IT systems to see if bad things were going on.
Unfortunately, this is a bit like finding a needle in a haystack. There will be trillions of bytes of data. Billions of accounting transactions. You’ll find something that looks odd, start tracing, only to find it was innocuous or a simple error later corrected.
Proving fraud is incredibly difficult. The bar on proof is very high for criminal convictions – mainly because we don’t want to send innocent people to jail. The reality is, most of the time there isn’t enough evidence. That said, the Insolvency Service strikes-off 1,000s of directors each year.
The work is front-loaded, the most costs are borne in the first few months. This was the case with Carillion. PWC and the OR expected most work to be complete after 4 or so months. Most liquidations last around 6 to 12 months. The final months dominated by wrapping up the investigation and tying up loose ends.
The SMs are required by industry standards to update the OR of work progress at least monthly. Most of the time, updates are far more frequent. Given the complexity and size of Carillion, these updates were on a daily basis.
In these appraisals, the OR will be reviewing and agreeing to PWCs work. He’ll be saying if it’s good enough or not. He’ll monitor the direction of work and decide if there are particular areas he wants PWC to focus on. If he ain’t happy he’ll tell PWC. Remember it’s the ORs neck on the line.
If necessary, the OR will petition the Court. Seeking permission to change the process, increase or vary fees or update the plan. If the Court isn’t happy, is says no.
The OR also must produce a report for the creditors. Often, the OR and liquidators will keep creditors up to date on a more regular basis (unless the creditor opts out of such communication).
As Carillion is wound down, the OR will get a better idea of the assets left for creditors.
Assets are paid out in a specific order BY LAW:
- Expenses of winding up: Liquidator fees and expenses are paid first
- Secured creditors with a fixed charge.
- Preferential creditors and ‘prescribed part creditors’.
- Secured creditors with a floating charge.
- Unsecured creditors.
- Interest on debts.
To reiterate it’s by law. You might not like it, I might not like it. Tough.
Order of fees
The OR is paid first. Their fees are paid to the Insolvency Service and are set by law: 11,000 per liquidated company plus 15% of recovered assets. As at the end of March 2018, the OR’s Carillion fees were £297k (£11k x 27 liquidations).
Next in line are the costs of the wind-up. The IP and SM’s fees, the running costs of the company during wind up.
This order is for a specific reason: if you aren’t gonna get paid you won’t do the work. This applies from accountants, to the building staff to the cleaners. If these people aren’t paid, they won’t work. If we didn’t have liquidators and staff doing work the wind up would be disorderly, more jobs are loss and less money recovered.
Next up are secured creditors (aka banks). They lend money but in return get collateral. Just like your mortgage. The deal is, you get a lower interest rate, in return, we get your house. That’s one of the reasons why loan interest rates are higher than mortgage interest rates.
Unfortunately, there’s rarely any money left after paying the secured creditors. That’s not because they gorge themselves on money, it’s because companies go bust because they were rubbish at business (or due to fraud).
Sadly in the case of Carillion, there isn’t even enough money to pay the expenses of wind up. Instead, the Insolvency Service will be picking up the tab. And therefore, ultimately, the taxpayer.
Petitioning the Court
The OR will set out the assets recovered and ask the Court for permission to distribute the money.
If the Court doesn’t like it, they tell the OR to go back to the drawing board. This sometimes happens, especially in administrations if the Court thinks the deal is a ‘bit dodge’ (very technical term there).
Once approved, the OR consults the lists of creditors drawn up during the liquidation process. This is generated as information is found and from creditors petitioning the OR.
In the case of Carillion, the list looks like this:
- Insolvency Service
- Nobody else
As mentioned above, the OR has to investigate what went wrong. They will produce a report for the Insolvency Service explaining this and recommending actions against the directors of the company if necessary.
Most of the time, this will be a recommendation to strike off the directors. Where fraud is thought to have occurred the Secretary of State will consider whether to bring any civil action. In the most egregious of cases, the file is passed to the Crown Prosecution Service to consider criminal fraud charges.
A quick word on this. Criminal fraud is very very hard to prove. We only send people to jail if we are sure they committed a crime (beyond reasonable doubt). Unfortunately, proving fraud to certainty is hard. It means very few ‘bad dudes’ get nailed for fraud. I could write mountains on this. If there’s interest I can write a piece on that (this one is long enough already).
An unhappy story
Companies going bust sucks. It is terrible. People lose jobs, businesses go under. Nobody can turn back time to stop it from happening. All we can do is to put a system in place to make the best of it.
I share huge sympathy for the victims of Carillion. It’s upsetting what happened. I can’t bring their money or companies’ back. But I can try to shed some light on what’s going on. That’s why I wanted to write this piece. Free of the bullshit, to explain exactly how the process works.
So let’s turn to our final question.
Is the process up to scratch?
In many respects, yes. In some important respects, no. The process above sounds great, and it works well. But there are some problems.
A long-winded process
Firstly, as you’ve probably realised the process is quite long-winded with lots of back and forth. The idea is to prevent mistakes from happening, but often the process takes too long. A litigation culture has emerged making IPs very reluctant to speed through the process. This means extra costs and a longer wait for money. I don’t have an easy solution for this. But many much smarter people than me have repeatedly asked the government to look into it.
Austerity has hurt services
Secondly, the Insolvency Service and Courts have been savaged by cuts. Things aren’t as dire as in other areas, but they are expected to do more with less. Talent has ebbed away into the private sector and there is a lack of resources available. They are doing the best they can and put on a brave face, but it’s hard. I wasn’t around in the ‘good old days’ when the Insolvency Service was a Goliath, but today only the simplest cases can be managed by the OR alone. That’s all a political choice. I don’t think we should be outsourcing justice and the law to the private sector, but successive governments don’t agree.
Small Creditors aren’t engaged with
Recovery rates and efficiency in the UK is relatively high compared to other countries, but with a concerning downward trend recently. But this hides an uncomfortable truth. Insolvency is dominated by big creditors – typically banks. Engagement with, and by, small creditors is very low. That’s understandable due to basic economics, but we can do better. Other countries have created professionals that represent the collective interests of small creditors in insolvency. I’d like the same here, with an automatically appointed professional to represent SMEs alongside the OR. The job might be like herding cats, but it’s better than nothing.
Lots of regulation doesn’t mean good regulation
Next up is regulation. Insolvency is probably the most highly regulated industry in the UK. The Insolvency Act 86, Insolvency Rules 2016, Insolvency Amendment 2017 are (erm…) ‘comprehensive’. IPs answer to the Insolvency Service, the Courts, the law and their professional bodies (accounting and law bodies).
Trouble is, nobody knows who should be policing what. The Court steps in if things go badly wrong, but most of the time it falls to the professional bodies. They treat discipline seriously (or at least my body, the ICAEW does). But whenever they ask for more powers they get rebuffed. This has been going on for years. I’ve found articles where the accounting bodies asked for more powers a decade ago. If I had to guess why, it’s because the government wants to keep power for themselves. Politicians want it under their control. Unfortunately, they just mainly grandstand rather than actually doing anything. In my opinion, it would be better to have a single regulator given stronger powers to ensure higher standards. [edit: just read now that ministers are considering giving the Insolvency Service some tougher powers! Good news if true.]
Fees are misunderstood
Fees are another issue. Recent changes mean that fee estimates have are published upfront. Trouble is, it’s impossible to accurately gauge fees. Sometimes the liquidation is straight forward, sometimes there’s been wholesale fraud. As such, for fear of not recovering costs, IPs quote the top end of fees, lest they have to go begging to the Court. Likewise, they publish the highest fee rates, just incase they have to seek the specialist expertise of the only world expert on Mongolian Salt mines. These get quoted in the press, everyone gets upset. But the fee rates I’ve seen are the standard City rates for professional services firms. They are dictated by the market. Being upfront with fees has increased transparency but caused confusion and disquiet. The Insolvency Service needs to improve the way it communicates the insolvency process to the public.
Too much in one go?
Finally, there is the investigations. This is an increasingly complex part of the process. Public expectations are for no stone left unturned. Unfortunately, this distracts from recovering assets. It would be much quicker to get the asset recovery done first and get people paid as quickly as possible and leave the bulk of the investigation work for later when it can be given more time and done properly.
To some extent, this is already the case. But the public demands (unrealistically) to know what went wrong almost immediately. It takes time to do a thorough investigation and I really urge more patience. I think its imperative of forensic accountants, like myself, to communicate better what work is required to properly perform the investigations.
- The Official Receiver, a civil servant, was appointed by the Court
- He answers to the Court
- He chose PWC to help him
- They set out their fees and liquidation plan at outset and got court approval
- Carillion is such a mess that the Official Receiver won’t get full fees, the taxpayer will have to foot some of the bill.
Specific problems with UK liquidation process:
- The process is long-winded.
- Cuts in services means Court and Insolvency Service deprived of money and resources needed to provide good service.
- Low engagement with SMEs, we need professional appointed by Court to represent SMEs.
- Consolidate regulations and bodies that regulate Insolvency Practitioners. Grant them stronger powers to punish bad Insolvency Practitioners.
- Publishing fees has brought transparency but also confusion. More education required.
- Splitting asset and recovery will speed up the return of money and improve investigations.
You can find out more about insolvency from the .gov website:
This is Part 1 of a 3-part series on Carillion and the hidden goings-on in the accounting world. You can read Part 2, on Carillion’s accounting here. You can read Part 3, on the ongoing investigations and aftermath here.
All the best,
Young FI Guy
P.S. Don’t worry, I’ll be back to ‘regular programming’ soon, I just had to vent.
P. P. S. As always, I moderate comments. If you post abusive comments like ‘accountants are scum’ I won’t approve them. Constructive comments are always welcome. I’ve tried to get all my facts right, I’m sorry if I got anything wrong. Be nice!