A lesson from Carillion

Avoid the unnecessary risk of becoming a creditor to an insolvent company by avoiding overpayments to contractors

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Summary

The importance of managing cashflow to contractors.

The clients of Carillion face many challenges.  One which could have been avoided is the potential need to recover any overpayments made on contracts.

In our experience, many clients unwittingly overpay contractors as they do not have the appropriate checks and balances in place to avoid doing so. They risk losing money in the event that a contractor becomes insolvent.

We recommend that clients review their procedures to gain assurance that they are paying contractors in line with the relevant contract.

The contract specifies payment terms

Contractors are entitled to payment in line with the contract. For example, under NEC ECC Option C contracts this is amounts paid to date and amounts due to be paid before the next assessment date.  The emphasis here is on the word paid.  A transaction may appear in a contractors accounting system but the physical movement of funds from the bank may not have happened.

Circumstances where contractors may be overpaid

In some cases clients make a decision to fund contractors’ cashflow by making advanced payments. This type of overpayment is an informed decision which takes into account any relevant risks.  There are however, other circumstances where a client may unwittingly overpay:

  • Contractors are very focused on cashflow due to tight margins and may overstate applications for payments to create positive cashflow. We have seen many instances where contractors have created significant positive cashflows resulting in amounts overpaid of up to £20 million.
  • Weaknesses in contractors accounting processes may cause an overstatement of costs and create positive cashflow.
  • In some cases, managers in clients’ organisations may pay contractors up front in order to spend money in a budget to avoid it being lost in the next budget setting round.

The risk to clients when a company becomes insolvent

Where a company is unable to pay its debts when they fall due (or has liabilities greater than assets on its balance sheet) it is insolvent.

If a contractor becomes insolvent and a client has overpaid, it becomes a creditor of the insolvent company. This means that the client:

  • May not get all or any of its money back
  • May become involved in the administration required to deal with an insolvent company through, for example, informal agreements, Company Voluntary Arrangements or Administration
  • May suffer negative cashflow whilst the insolvent company is dealt with

The traditional substantiation approach to reviewing costs may not provide assurance against the risk of overpayment

The traditional, “Substantiation” approach employed by cost checkers in many organisations to check payments, does not typically regularly check when funds move and the accuracy of forecasting future payments.

It may well result in any overpayments being missed.

Conclusion

Our advice is that clients make sure that they have procedures in place to provide them with reliable assurance that contractors are being paid in line with the contract and that they are avoiding the unnecessary risk of becoming creditors of insolvent companies by overpaying.