Tutorial Assignment 3: The Carillion and Southern Cross Cases

This tutorial focuses on the collapse of two companies involved in delivery of very different types of
public services:

- Carillion, a major contractor with the government for a range of infrastructure projects,
which collapsed in early 2018 and
- Southern Cross responsible for running a chain of care homes which collapsed in 2011.

Read the selection of newspaper articles and commentaries below. Look for further sources on the
collapse on the internet if you wish to find out more.

Be prepared to discuss the following questions:

- Why did Carilion and Southern Cross collapse and who was to blame?

- What were the consequences of the collapses?

- Compare and contrast the collapses of Carillion and Southern Cross: how and why were they
similar or different?

- Overall, what lessons can be drawn?

Carillion Q&A: The consequences of
collapse and what the government should
do next
January 17, 2018 3.17pm GMT
John Colley, Warwick Business School, University of Warwick

Construction giant Carillion has gone into liquidation. The UK’s second-largest construction
firm was one of the government’s biggest contractors, involved in huge infrastructure
projects like the HS2 rail link and the Royal Liverpool University Hospital. It also provides
services across the public sector such as running libraries, schools and prisons. Here’s what
you need to know about Carillion’s collapse.

Why did the government keep placing work with Carillion despite profit warnings and
huge debts?

It is possible that the government did this to keep Carillion solvent. But, as we’ve seen, there
is always a day of reckoning.

Carillion seems to have a number of long-term contracts which have been losing money.
There is a view by some I’ve spoken to in the industry that they have been tendering at low
prices to keep winning work. In the contracting industry the developer pays significant sums
up front to get projects moving. The projects can last a number of years and management has
to assess whether the project is losing money or will make a profit. In effect, Carillion may
have been using the new money from contract wins to shore up the old loss making contracts.

Some of the issues arose during the recession that followed the 2007-08 financial crisis, when
contractors bid lower prices to keep winning work and keep their sub-contractors and
employees occupied. These contracts have been losing money ever since. Balfour Beatty ran
into similar problems in 2015 when major losses were taken on contracts. Fortunately, they
had plenty of saleable assets which would act as collateral for further borrowing, and they did
not have the debt levels of Carillion.

Clearly, there are big questions which the directors and the auditors need to answer regarding
taking so long to realise their predicament. There is also a question around directors’ bonuses
and pay during the last few years and whether the accounts should have told a different story.

We can be reasonably certain that no one will come out of the catastrophic collapse of
Carillion with any real dignity.

What are the consequences of collapse?

Carillion’s collapse leaves almost £1 billion of debt, more than £500m of pension deficit and
around 30,000 unpaid subcontractors. Work is ceasing on both public and private contracts as
subcontractors down tools until they receive reassurance that they will be paid – for past and
future work. The liquidator and Official Receiver is asking subcontractors to keep working
but they are likely to require strong reassurances regarding payment.

The cash paid by government and private developers into Carillion before its collapse –
which had not been previously paid to subcontractors – can be presumed to be lost.
Carillion’s head office will probably close and the regional management structure dissolved
as job losses mount.

Broadly, the business has two parts: major capital contracts (building of hospitals, roads,
railways and other major structures) and facilities management (buildings maintenance,
security, catering, running prisons and so on).

Facilities management is predominantly, but not exclusively, for the government. Clearly,
these latter jobs were originally undertaken by public sector workers until outsourced to
private contractors.

In this area, it can be argued that the government has a choice as to whether it nationalises
this work or continues to rely on private contractors. There is little doubt that private
contractors are cheaper because the market to provide these services is highly competitive.
But there are risks over the quality of work, failure to perform and, as in this case,
liquidation.

There are plenty of businesses willing to provide these services, such as Serco and Sodexo.
Retendering is likely to produce a low cost solution but the government should learn from its
mistakes with the Carillion experience and make sure it gives the contract to a financially
stable company, including substantial penalties for poor performance.

Government-funded major capital schemes can only be performed by major external

contractors. There are only a few businesses which have the size and specialist skills to do
this work. These include Balfour Beatty, Galliford Try, and a few others.

There are also overseas contractors but governments typically give as much work to domestic
firms as possible, provided the skills and capabilities exist.

What should the government do?

The government has made some promises to pay subcontractors working on public contracts.
But the key question for the 30,000 subcontractors is what will happen to the money owed for
work over the last few months? If this is not paid then they may become insolvent and the
major hospitals, roads and railways will be delayed for a considerable time.

In effect, the government and other developers have paid this money into Carillion but it is
lost. To ensure solvency and continued work on the major projects, the government will have
to stand these losses and ensure that subcontractors are paid what they are owed.

They have no reason, however, to cover the private contracts. These are for the private
developers to make a decision over.
Nationalising Carillion would be highly risky for several reasons. The government would
have to take on all the liabilities for both public and private contracts. Other major contractors
would, in effect, have to compete with a government-owned contractor for work which would
scarcely be ideal as the government does not have to make a profit or pay for its capital.
Finally, what does the government know about contracting? It would appear very little from
this saga.

What we do know is that these major public-private partnership schemes will continue and
that the bulk of employment will continue albeit after some disruption. Continued
competition does drive a good deal for developers, including the government, but, as we have
seen, also has its risks.
Where did it go wrong for Carillion?
By Daniel Thomas Business reporter
15 January 2018

Construction giant Carillion is going into liquidation after its huge financial troubles
finally overwhelmed it.

The UK's second-largest construction company buckled under the weight of a whopping £1.5bn
debt pile.

Despite discussions between Carillion, its lenders and the government, no deal could be reached
to save the company.

The big concern is over the disruption this might cause, given Carillion holds so many
government contracts - from building hospitals to managing schools.

It also employs about 20,000 people in the UK and has more staff abroad.

So how did the company get into such dire straits?

What does Carillion do?

Carillion specialises in construction, as well as facilities management and ongoing maintenance.

It has worked on big private sector projects such as the Battersea Power station redevelopment
and the Anfield Stadium expansion.

But it is perhaps best known for being one of the largest suppliers of services to the public sector.

Notably, it is part of a consortium that holds a contract to build part of the forthcoming HS2 high
speed railway line, and it is the second largest supplier of maintenance services to Network Rail.

It also maintains 50,000 homes for the Ministry of Defence, manages nearly 900 schools and
manages highways and prisons.
How big is it?
Very. Carillion employs 43,000 staff globally, around half of them in the UK where it does most of
its business. It also operates in Canada, the Middle East and the Caribbean.

In 2016, it had sales of £5.2bn and until July boasted a market capitalisation of almost £1bn. But
since then its share price has plummeted, leaving it worth just £61m.

What went wrong for the firm?

Some argue that it overreached itself, taking on too many risky contracts that proved
unprofitable. It also faced payment delays in the Middle East that hit its accounts.

Last year, it issued three profit warnings in five months and wrote down more than £1bn from the
value of contracts.
This made it much harder to manage its mountainous £900m debt pile and £600m pension
deficit.

In December, the firm convinced lenders to give it more time to repay them.

However, the company's banks, which include Santander UK, HSBC and Barclays, were
reluctant to lend it any more cash.

What were Carillion's biggest setbacks?

Among its biggest problems were cost overruns on three public sector construction contracts:

 The £350m Midland Metropolitan Hospital in Sandwell. The opening was originally
scheduled for October 2018, but difficulties with the heating, lighting and ventilation
systems forced a delay of the launch date to spring 2019

 The £335m Royal Liverpool Hospital. The new 646-bed hospital was due to be
finished by March 2017, but the completion date has been repeatedly pushed back
amid reports of cracks in the building

 The £745m Aberdeen bypass, which is being built by the Aberdeen Roads Ltd
consortium, a joint venture that includes Balfour Beatty and Morrison Construction
 alongside Carillion. It is due to open in spring 2018. One key stretch was due to open
a year earlier, but was delayed because of slow progress in completing initial
earthworks. Last month, environment watchdogs slapped a £280,000 penalty on the
consortium for polluting two of Scotland's most important salmon rivers

Why does its collapse matter?

As Carillion is such a big supplier to the public sector, some fear there will be a lot of disruption.

Labour MP Jon Trickett told Parliament before the announcement that if it went under, it would
risk "massive damage" to a range of public services.

Thousands of jobs also hang in the balance. Unions have said workers do not deserve to be
caught in the crossfire and have urged the government to safeguard their jobs and bring
Carillion's contracts back in house.

The government, which has praised Carillion's work on projects such as Crossrail, has said it will
provide funding to maintain the public services run by the firm.

Analysts say Carillion had a large order book of business lined up.

The big question is, who will ultimately pick up its loss-making public contracts - another
outsourced services provider or the government itself?
Economist
Where did Carillion go wrong?
Jan 18th 2018

LABOURERS building the new Midland Metropolitan Hospital in

Birmingham got a rude shock when they arrived for their morning
shift on January 15th. They were told to go home; they had been
laid off. Meanwhile, in Oxfordshire, the county council was putting
the fire brigade on standby to serve school meals. Such were just
a few of the immediate consequences of the collapse that
morning of Carillion, Britain’s second-largest construction firm,
with debts of about £1bn ($1.4bn) and pension liabilities of almost
as much again.

The total cost in lost jobs and business has yet to be counted. But
another casualty of the company’s capsize may be the business
model that went so badly wrong there, and which plenty of other
firms in the outsourcing industry share.

Carillion employed 43,000 people worldwide, almost half of them

in Britain. It began as a construction company, building
everything from the doughnut-shaped headquarters of GCHQ,
Britain’s signal-intelligence agency, to hospitals and football
stadiums. It later began providing all manner of services for both
the public and private sectors, dishing up meals in schools,
maintaining bases for the Ministry of Defence, and much else.
Many of its projects were commissioned under the Private Finance
Initiative (PFI), in which contractors foot the cost of building and
are repaid by the government over several decades. Almost all
the work that Carillion won was outsourced to subcontractors,
who would often sub-subcontract it in turn.

The platoons of small firms that did most of Carillion’s work will
thus be most affected by its demise. Rudi Klein, head of the
Specialist Engineering Contractors’ Group, representing
thousands of engineering firms, estimates that Carillion owed
about £2bn to 30,000 or so firms. That does not include the
unknown cost of retentions, the cash that Carillion was holding
back until companies had finished the job. Many will never get
their money, damaging Britain’s slender supply chain. At least the
government has stepped in to protect those doing public-sector
work; Carillion had about 450 government contracts, constituting
about a third of the company’s revenues in 2016.

But it was this work that contributed to Carillion’s undoing,

highlighting the basic flaw in its business model. Construction is a
perilously low-margin business to begin with. To expand the
business and keep enough cash rolling in to pay creditors and
shareholders, Carillion’s bosses bid ever more aggressively for
public-sector contracts, especially in the wake of the financial
crash in 2008, when such work was scarce. That is when three big
deals were signed that have gone sour: to build hospitals in
Liverpool and Birmingham, together worth £685m, and for a
share in a £550m roadbuilding contract in Aberdeen.

All three projects hit snags common to the building trade. In

Liverpool, for instance, workers found asbestos on site and cracks
appeared in the new building. Under the terms of the deals,
Carillion had to absorb the extra costs, on projects that were
barely profitable in the first place. The company also ran into
trouble in Qatar, where it got into a dispute over a payment of
£200m that it was owed for work on the 2022 World Cup. The
result was a profit warning last July, after the company admitted
to unexpected over-runs of £845m, which sent the share price
tumbling. Carillion continued to win business, notably from the
government, which awarded it a contract for £1.4bn of work on
the HS2 railway even as investors bet on the firm’s collapse. But
after more profit warnings, the banks refused to lend it any more.

Public-sector tenders are supposed to consider the quality of bids

as well as the price, but in practice contractors have found that
“bidding at a low price is usually the best way to win,” says Peter
Kitson, a lawyer at Russell-Cooke. Companies bank the upfront
payments and hope they can make money by charging for the
extra work that nearly always comes with infrastructure projects.
If, as happened to Carillion, extra costs arise, the deal can quickly
become loss-making.

But Carillion’s management was also culpable. The firm expanded

too fast, acquiring businesses that it did not understand. It paid
£306m for Eaga, for instance, a supplier of green-energy
products, only months before the government cut subsidies that
homeowners got for installing solar panels. As Carillion was failing
and its pension fund slipping into deficit (see article),
shareholders continued to receive dividends and the firm’s boss
trousered a £1.5m pay package. Even the Institute of Directors, a
business lobby, condemned Carillion’s board for rewriting
company rules to protect executives’ bonuses if the company
failed. On January 17th the Insolvency Service said that it was
stopping all further payments.

Who wants to be a Carillion heir?

Shares in its rivals, such as Serco and Kier, rose after the firm
imploded, on the expectation that they would pick up some of
Carillion’s business. Yet many of the problems that sank the
company are common to the outsourcing industry. Interserve,
which has an annual turnover of £3bn, issued two profit warnings
last year, following technical problems at a waste-to-energy plant
in Glasgow. Not long ago Balfour Beatty, Britain’s largest
construction firm, issued seven profit warnings in the space of
two-and-a-half years, after accepting too much work at low
margins. Construction News, a trade paper, found that last year
Britain’s ten largest builders made a combined pre-tax loss of
£53m; the average pre-tax profit margin was -0.5%.

And now there is intense pressure on outsourcers to change their

ways. The government has launched an inquiry into the Carillion
saga. It may also re-examine its procurement processes. On
January 18th the National Audit Office published evidence that PFI
is a pricey way to fund infrastructure, and that it does not reliably
bring benefits. Carillion’s competitors may be glad to have seen
off a rival, but they are operating in a troubled industry that is
under more scrutiny than ever before
Carillion: a month on, employees, partners
and rivals feel the pain
Rob Davies

Wed 14 Feb 2018

A month after the government contractor Carillion folded, the effects of its failure are still
filtering through.

The latest cost of the company’s collapse has landed on the construction firm Galliford Try,
which is to tap shareholders for £150m after taking a £25m hit on the cost of picking up
Carillion’s share of their Aberdeen bypass joint venture.

Galliford Try needed the extra cash, it said, so that it did not have to divert money from other
projects it was working on. Its shares slumped more than 18%, wiping more than £150m off
its stock market value.

MPs have raised fresh concerns that former Carillion staff who have been made redundant are
being left in the dark and could wait six weeks for redundancy and statutory notice pay.

The outsourcing firm Serco emerged as a rare winner from Carillion’s failure: it had
previously agreed a £48m deal to take over NHS contracts from the company, but will now
pay £30m.

As the Insolvency Service picks over the remains in an effort to save jobs and keep public
services running, here are the key developments:

Jobs

Carillion employed about 19,500 people in the UK. The official receiver, an office of the
government’s Insolvency Service, is trying to find new employers for them, mostly by
identifying other businesses willing to take over contracts.

So far, 6,668 jobs have been saved, more than a third of the company’s headcount. But nearly
1,000 staff have already been made redundant and a further 11,800 are hanging in the
balance.

It looks likely that more jobs will be rescued, after the Insolvency Service reported a “lot of
interest” from companies keen to buy out Carillion’s contracts.
But Frank Field, chair of the work and pensions committee, and Rachel Reeves, his
counterpart on the business committee, wrote to the Insolvency Service on Wednesday with
fresh concerns. They said staff had not been told how long they would have to wait for
redundancy and statutory notice pay and warned it could be six weeks before payment
arrived.

However, some suppliers to Carillion have already laid off staff and the full impact on jobs in
Carillion’s supply chain is unlikely to be clear for months.

What was Carillion?

The Wolverhampton-based firm was second only to Balfour Beatty in size.

It was spun out of the Tarmac construction business in 1999 and steadily took over rivals,
such as Mowlem and Alfred McAlpine. It expanded into Canada and built a construction arm
in the Middle East.

Carillion then diversified into outsourcing, taking on contracts such as running the mailroom
at the Nationwide building society to helping upgrade UK broadband for BT Openreach. It
took over running public service projects, ranging from prison and hospital maintenance to
cooking school meals. In 2017 a third of its revenue – £1.7bn – came from state contracts. It
employs 43,000 people, with more than 19,000 in the UK.

Notable construction projects

• GCHQ government communications centre in Cheltenham (2003)

• Beetham Tower, Manchester (2006)

• HS1 (2007)

• London Olympics Media Centre - now BT Sport HQ (2011)

• Heathrow terminal 5 (2011)

• The Library of Birmingham (2013)

• Liverpool FC Anfield stadium expansion (2016)~

• Midland Metropolitan Hospital in Smethwick (due 2019)

• Aberdeen bypass (due 2018)

• Royal Liverpool University Hospital (due 2018, behind schedule)

Government contracts

• NHS – managed 200 operating theatres; 11,800 beds; made 18,500 patient meals a day
• Transport – “smart motorways” to monitor traffic and ease congestion; work on HS2; track
renewal for Network Rail; Crossrail contractor

• Defence – maintained 50,000 armed forces’ houses; a £680m contract to provide 130 new
buildings in Aldershot and Salisbury plain for troops returning from Germany

• Education – cleaning and meals for 875 schools

• Prisons – maintained 50% of UK prisons.

Photograph: Christopher Furlong/Getty Images Europe

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Suppliers and small firms

Carillion subcontracted much of its private and public sector work – from cleaning to
landscaping – to an estimated 30,000 small companies, many hired for their specialist
expertise.

It was also a notorious late payer, according to the Federation of Small Businesses. That
means many companies that were already operating on wafer-thin margins have lost a
lucrative client that owed them money.

Court documents revealed last month that those companies are unlikely to get anything back,
at most a penny in the pound. Writing off these outstanding bills
Carillion bosses prioritised pay over
company affairs, MPs hear
Rob Davies

Wed 7 Mar 2018

Former Carillion directors seemed to be more concerned about their pay

deals than the operation of the company in the year leading up to its
collapse, according to evidence given to MPs by City investment firm
BlackRock.

The allegation came during the latest hearing of a joint inquiry by two
Commons select committees, in which auditor KPMG faced fresh
criticism and the investment fund, Aberdeen Standard Investments,
appeared to back calls for the big four accounting firms to be broken up.

BlackRock managing director Amra Balic told MPs from the business and
pensions committees that the investor’s last conversations with the board
before Carillion’s collapse were about pay.

“My team meets with the board and has interaction with the board,”
Balic said.

“Most recently in 2016 and 2017 that was around executive pay, where
we received a letter from the remuneration committee looking to allow
for more opportunity, larger bonuses for the executives and we
categorically said no to that.

“It seems that the board was focusing more, thinking again how to
remunerate executives rather than actually what was going on at the
business.”

Balic added there had been “definitely too much focus at the board level
around remuneration.” She also revealed that BlackRock’s customers
made £36m betting that the company’s shares would fall.

Her comments on pay follow disclosures that Richard Howson, who

headed the company from 2012 until July 2017, pocketed £1.5m in 2016,
including a £122,612 cash bonus and £231,000 in pension contributions.

As part of his departure deal, Carillion had agreed to continue paying

Howson a £660,000 salary and £28,000 in benefits until October 2018.
The evidence session also saw leading investment firms back calls to
address a lack of competition between the big four accountancy firms
that audit the books of major companies, including Carillion’s auditor
KPMG, PwC, EY and Deloitte.

Murdo Murchison, the chairman of Carillion’s former largest investor

Kiltearn Partners, said: “There appears to be a lack of competition in a
key part of the financial system, that periodically causes a lot of
participants in that system a lot of trouble.”

He said Kiltearn had written to directors at other companies in which it

invests that are audited by KPMG, asking them to assess the “quality of
service” they are receiving.

“We remain puzzled by the fact that someone can be six weeks in a job
and discover material issues in accounts that have been approved [by
auditors].

“There appear to have been issues that were hidden in plain sight but
were not visible to auditors. That’s a puzzle.”

“I do share the concern over the audit industry,” said Euan Stirling,
Aberdeen Standard Investments’ head of stewardship. “There is a lack of
competition.”

Murchison also voiced concern about the length of time that one
company can act as auditor to the same firm, pointing out that KPMG had
analysed Carillion’s books since 1999.

He cast doubt on claims by former Carillion directors and KPMG that the
company’s finances deteriorated rapidly in spring 2017 when four key
contracts were found to be underperforming.

“The notion that it all happened in a matter of a couple of months in early

2017 is incredible. There must have been prior issues that were not
presented to investors that cause that quite calamitous collapse,” he said.

“The scale here is extraordinary. Carillion, we would argue and hope is

an exception to the general rule that an investor can rely on audited
accounts.”

Stirling said it had become clear that Carillion’s former directors

were presenting a better picture of the company’s finances than was
correct.

“There was a gloss to the [shareholder] presentations that we felt did not
reflect true business circumstances.
“Our dealings with the company suggested a confidence in their
approach that wasn’t necessarily supported by the facts.”

Referring to non-executive directors, who are tasked with questioning

the company’s management, he said they were “hoodwinked as much as
anyone else”.

The Guardian approached KPMG and former directors of Carillion for

comment but had not received a response from either at the time of
publication.
BBC
Carillion collapse to cost taxpayers £148m
 7 June 2018
 There will also be wider costs to the economy, Carillion's customers, staff, the supply
chain and creditors, the NAO said in a report.

When it was liquidated with debts of £1.5bn in January, the firm had about 420 UK public sector
contracts.

Since then, nearly two-thirds of its UK workforce have found new jobs.

The NAO said 11,638 Carillion workers in the UK, about 64% of the total, were now employed
elsewhere. Of the rest, 2,332 - 13% of the total - had been made redundant and the remaining
3,000 were still employed by Carillion.

The NAO said the £148m estimated loss was subject to a range of uncertainties, such as the
timing and extent of asset sales.

However, it would be covered by money already provided by the Cabinet Office to help finance
the costs of liquidation.

Almost all services provided by Carillion continued uninterrupted after the firm's collapse,
although work on some construction projects stopped, including building work on two hospitals
funded by Private Finance Initiatives, the NAO said.
Carillion's non-government creditors were unlikely to recover much of their investments, the NAO
said.

In addition, the firm's extensive pension liabilities, which amounted to £2.6bn at the end of June
last year, would have to be compensated through the Pension Protection Fund.

The head of the NAO, Amyas Morse, said the government had "further to go" in protecting the
public interest in cases such as Carillion.

He added: "Government needs to understand the financial health and sustainability of its major
suppliers and avoid creating relationships with those which are already weakened."

Meg Hillier, chair of the Public Accounts Committee, agreed this needed further work. She told
the BBC's Today programme: "My committee is looking at the wider relationship between
government and large suppliers. There are 27 other companies with large contracts across
government.

"We need to really examine this relationship between these large outsourcing companies and
government. We'll be talking to those big suppliers over the next few weeks and publishing our
findings by the summer."
One of those companies, Mitie, reported its results on Thursday.

It made an £8m loss, after one-off costs were taken into account, compared with a £40m loss the
year before.

Its chief executive, Phil Bentley, told the Today programme: "We have made the point it is not
just abut pricing, it is about process. We think we're very different to Carillion, which was brought
down by construction contracts and we're not in that business."

Government 'hoodwinked'
A spokesman for the Cabinet Office said the government's priority was to ensure public services
provided by Carillion continued to run smoothly and safely.

"The plans we put in place have ensured this, and we continue to work hard to minimise the
impacts of the insolvency, having safeguarded over 11,700 jobs to date," he said.

Labour's shadow Cabinet Office minister, Jon Trickett, said: "The government's dogmatic
commitment to the failed outsourcing ideology blinded it to the large risks. The Tories were more
concerned about the commercial interests of big business than protecting taxpayers' money or
public services.

"In government, Labour would end this racket and would introduce a presumption in favour of
bringing contracts back in house."

Frank Field MP, who chairs the Work and Pensions Committee, said: "This invaluable report
adds new weight to what we found: Carillion hoodwinked the government as they did many
others who were so naive as to trust their published accounts."

Mr Field accused Carillion's directors of "extraordinarily negligent planning" in their oversight of

UK public sector construction contracts.

Tim Roache, GMB general secretary, described the report as "damning".

He added: "Carillion held £1.7bn of public contracts, but this report suggests that ministers were
working for the company, not the other way around.

"The same corporate bosses who are responsible for Carillion's failure pocketed millions while
going cap in hand to the taxpayer, begging for help to prop up their failing business model."
Carillion collapse exposed government
outsourcing flaws – report
Graeme Wearden

Mon 9 Jul 2018

The folly of using contractors to drive down the cost of providing public services has been
exposed by the collapse of Carillion, an official report has shown.

The House of Commons public administration and constitutional affairs committee found
there are fundamental flaws in the way the government awards contracts because of “an
aggressive approach to risk transfer”.

The report, published on Monday, found that ministers try to spend as little money as
possible when awarding contracts while forcing contractors to take unacceptable levels of
financial risk.

Often the government does not fully understand the risks it is transferring to private
companies, the committee says. It also fails to appreciate differences in quality provided by
rival bidders because procurement decisions are driven by price.

As a result, public services have deteriorated as companies concluded that cost, rather than
quality of services, is the government’s consistent priority.

Sir Bernard Jenkin, the Conservative MP who chairs the committee, says: “It is staggering
that the government has attempted to push risks that it does not understand on to contractors
and has so misunderstood its costs. It has accepted bids below what it costs to provide the
service, so that the contract has had to be renegotiated.”

Jenkin urged ministers to learn lessons from the demise of Carillion, which was one of the
biggest corporate collapses in years.

“Public trust requires that outsourcing better reflects public service values,” Jenkin said. “The
government must use this moment as an opportunity to learn how to effectively manage its
contracts and relationship with the market.”

Q&A

What government contracts did Carillion hold?

NHS
• Managed facilities including 200 operating theatres and 11,800 beds
• Made more than 18,500 patient meals per day
• Helpdesks dealt with 1.5m calls per year
• Engineering teams carrying out maintenance work

Transport
• Built 'smart motorways' – which ease congestion by monitoring traffic and adjusting lanes
or speed limits – for the Highways Agency
• Major contractor on £56bn HS2 high-speed rail project
• Upgraded track and power lines for Network Rail
• Major contractor on London’s Crossrail project
• Roadbuilding and bridges
The rise and fall of Southern Cross
Ten years of triumph followed by a dramatic fall from
grace: we chart the history of the largest operator in the
care homes sector

A Southern Cross Healthcare home in Wiltshire. Photograph: Tim Ireland/PA

Graeme Wearden
Wed 1 Jun 2011 16.29 BST
Southern Cross, the troubled care home operator, stands on the
brink of collapse this week just fifteen years after it was created.
The company was set up in 1996 by a businessman named John
Moreton, who had made his first fortune in his twenties during
the North Sea gas boom. Moreton developed his new venture
during the last major shake-up in the care industry, around the
turn of the millennium, when government funding cutbacks and
tougher care standards forced many homes to close or be sold off
cheaply.

New operators such as Southern Cross Healthcare benefited, and

the company had become a significant operator by 2002, with
140 sites. At that point, venture capital firm WestLB stepped in
and bought Southern Cross for £80m as part of a management
buyout. At that time, the City was confident that the care home
sector needed to consolidate.

Two years later, US private equity firm Blackstone swooped,

paying £162m for the company, which by that stage had 162 care
homes. Blackstone made its ambitions clear from the start,
pledging to turn Southern Cross into "the leading company in the
elderly care market".

Blackstone went on to buy NHP, one of Southern Cross's largest

landlords, in a £1.1bn deal which also increased Southern
Cross's size by another 192 leased homes.

Further acquisitions followed, turning Southern Cross into the

largest operator in the sector. NHP was sold off in March 2006,
followed by a flotation of Southern Cross itself on the London
stock market that summer.

Southern Cross performed well during its early days as a quoted

company, nearly doubling its share price during the first year.
That proved good news for Blackstone, which sold its final stake
in the company in March 2007. It also continued to expand as
demand for care home places kept rising, due to increased
lifespans and falling capacity across the sector.
Then, in the summer of 2008, the tale turned desperately sour
when Southern Cross's expansion strategy was derailed by the
financial crisis.

The company had been buying properties then selling them on

again, while keeping a long-term lease. In the heady days before
the collapse of Lehman Brothers, Southern Cross suddenly found
itself unable to meet a £43m loan repayment deadline, because it
could not find buyers for its property assets. In another blow, it
warned the City that disappointing occupancy levels meant its
earnings would not meet expectations.
The double whammy of profit warning and financing crisis sent
its share price crashing from over £3 to just 130p in a single day.
Chief executive Bill Colvin quit later that year, after Southern
Cross began selling assets at a loss in an effort to repay its debts.

Colvin was one of three senior directors who had received

£36.6m after selling shares in Southern Cross in early 2008,
when they were trading at 550p.
Southern Cross managed to renegotiate a new deal with its
banks, and tried to ride out the storm. Then in May 2010, the
crisis intensified again when Southern Cross revealed that local
governments were sending fewer people into its homes, and
pushing for lower fees.

In August, Southern Cross posted a profits warning, blaming the

austerity cutbacks for a steady decline in occupation rates. These
falling revenues rapidly left Southern Cross struggling to pay the
leases on its properties.
Hopes of a rescue takeover faded this year, prompting chief
executive Jamie Buchan to warn that its rent bill was simply
unsustainable. Many of its rents run for 25 years, and are subject
to yearly upwards-only rent reviews.
Corporate restructuring expert Christopher Fisher became
chairman in April, as the fight to avoid insolvency continued. In
May it pleaded with its landlords to cut its rents by 30%, and this
week it took the decision itself.
Southern Cross set to shut down and stop
running homes
Published
11 July 2011
Care home operator Southern Cross is set to shut down after
landlords owning all 752 of its care homes said they wanted to
leave the group.
"It is currently envisaged that the existing group will cease to be an operator of homes," the
firm said.
Southern Cross added that the landlords were still committed to providing continuity of care
to its 31,000 residents.
Trading in the company's shares has been suspended.
The Darlington-based Southern Cross and its landlords and creditors are a month into a four-
month restructuring period, which was agreed in crisis talks in June.
The statement said that the details of the restructuring were not yet settled and there was still
a possibility of further changes.
It had been expected that some of the landlords would leave the group, leaving Southern
Cross operating with between 250 and 400 homes, but now it appears that the group is to
disappear altogether.
'Regret'
The process began when the UK's biggest care home operator said it was unable to pay its
rent bills to its landlords.
The statement said that little or no value would be left for the shareholders.
"We regret the loss of value which shareholders have experienced," Southern Cross chairman
Christopher Fisher said.
About 250 of the homes will immediately begin to be transferred to other operators.
The owners of the rest of the homes are still finalising their plans, but they may end up using
the existing Southern Cross back-office staff and some of its management.
'Worrying' time
"We anticipate that the period of uncertainty which we have been experiencing will now
draw to a close," Mr Fisher added.
But Michelle Mitchell at Age UK, said that despite the promises about continuity of care,
"this has been a really worrying few months for Southern Cross residents and their families,
with these latest developments only adding to their concern".
Labour MP John Mann called on the government to intervene to make sure that care home
residents were not forced to move.
"No resident should be forced to move out of their home and in the big sell-off there must be
no cherry picking of the better properties," said Mr Mann, who has four Southern Cross
homes in his constituency.
"Government intervention is needed now so that resident needs are put first and to prevent an
even greater disaster from unfolding."
Fee question
Martin Green, chief executive of the English Community Care Association, said the collapse
of Southern Cross showed there were serious problems with the funding of care in the
independent sector.
"I think the Southern Cross issue which has come to a head today, is very much an issue that
other providers are facing because of the levels of resource that they have to deliver care on,"
he told BBC Radio 4's You and Yours programme.
"Fees are a really big issue and we've had several years of nil increases, and of course we've
had inflation rates running at 4-5%."
David Rogers, chairman of the Local Government Association's Community Wellbeing
Board, said: "Councils take the welfare of care home residents extremely seriously and
throughout this process that has always been their priority."
"It's greatly reassuring, and testament to the good work which has been going on behind the
scenes and the resilience of the care home system, that a solution has been found which will
hopefully avoid major upheaval for the vulnerable people involved."
Southern Cross's incurably
flawed business model let down
the vulnerable
The collapse of Southern Cross has re-ignited the debate over
the role of private finance in the care-home sector

Richard Wachman
Sat 16 Jul 2011 00.08 BST

S outhern Cross will soon cease to exist, as landlords take

back leases linked to the firm's 750 care homes because it can no
longer afford the rent. New operators will be brought in and
Southern Cross will be remembered as a financial failure that
heaped shame and ignominy on the sector. But how did it come
to this? Britain's largest care homes operator, with 31,000
residents, was once a force in the land.
It's easy to see why. Not so long ago, running care homes for the
elderly and sick seemed an easy way to make money in a country
where the population was greying at a faster rate than anyone
could remember. Most elderly residents were bankrolled by local
authorities, offering private-sector operators a steady stream of
income from the taxpayer.

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Interest rates were low, allowing companies to borrow to expand
their estates at a time when banks were falling over themselves
to furnish loans. Councils were feeling generous and agreed
annual fee increases ahead of the rate of inflation, making it
simple for operators to cover their costs.

Against this background, Southern Cross prospered. A former

executive remembers: "It sounds corny, but it really did seem we
were in a land flowing with milk and honey."

By 2003, the company owned more than 100 homes and was
attracting the attention of investment bankers. "You could see
the firm was going places – management was ambitious and as it
grew, so did the financial returns," said the former executive.

A year later, US private equity group Blackstone acquired

Southern Cross in a deal worth £167m. Ludicrously, as it turned
out, Blackstone supported a sale-and-leaseback business model
that was all too common at the time.

Under this system, Southern Cross's operating company and

property assets were separated. It was blatant financial
engineering but it made sense on paper: acquisitions could be
financed by spinning off the bricks and mortar into a different
company, selling it on to property investors and then using the
proceeds to buy more care operators.

Blackstone's biggest transaction was the £564m purchase of

NHP, a property company that owned the leases to many of
Southern Cross's homes. Blackstone later sold NHP for £1.1bn to
a fund backed by the Qatar Investment Authority. As with other
deals, Southern Cross's Middle Eastern landlord insisted on
upwards-only annual rent increases, of around 2.5%.

As long as the boom lasted, Southern Cross was able to generate

large amounts of cash and invest in its homes to make them
attractive to local authorities. The sale-and-leaseback model
worked fine when property prices were heading north: property
players were happy to invest, and Southern Cross was willing to
agree to upwards-only rents as it could borrow at cheap rates.

But after the financial crisis, Southern Cross was hit by a triple
whammy: falling property prices put the brakes on what proved
to be a reckless expansion programme; tough economic
conditions saw local councils freeze or lower fees for residents;
and worst of all, the company was now locked into rising rents at
a time when income was being squeezed. It was a recipe for
disaster.

Even during the best of times, profit margins in the care homes
business are thin; as long as occupancy rates remain comfortably
over 85%, a company that leases its homes from landlords can
make good profits. But below that level, it becomes harder to
break even, leaving businesses vulnerable to relatively small
changes in the trading climate.

Research has shown that Southern Cross's occupancy rates fell

every year from 2006. And it cut capital expenditure in its
homes, hitting standards of care for residents, making them less
appealing to local authorities.

A version of the sub-prime crisis was hitting the sector and other
operators felt the pinch, with several seized by creditors.
Barclays Capital, for instance, took over Care Principles, a
company that looked after patients who had been sectioned
under the Mental Health Act.

At Southern Cross, deteriorating standards of care were seeping

into local media reports. By 2009, Southern Cross homes were
attracting the attention of the Care Quality Commission. A report
in the Observer last month disclosed that nearly 30% of the
group's 581 centres in England had been served with
improvement orders by CQC inspectors.
The tide had turned against Southern Cross for another reason.
Local authorities were trying to care for more elderly and frail
people in their own homes, so by the time they arrived at
residential centres, their condition had deteriorated to include
dementia, immobility and incontinence, which are more
expensive to care for. Southern Cross was forced to take on more
overheads as revenues declined, and all the while there was the
ticking timebomb of a rising rent bill, which had reached £230m
a year by January.

Blackstone left long before the bust. It floated the company for
£640m in 2006 and sold its last Southern Cross shares a year
later. In total, the private equity firm made a profit of £1.1bn on
its original investment. Others were left to pick up the pieces.

Jamie Buchan, the chief executive who took over two and a half
years ago, never really had a chance. He was reluctant to talk
about what had gone wrong yesterday, but in May he told
the Financial Times: "I've never come across this lease structure
before. The model doesn't work through hard times."
The failure of Southern Cross has re-ignited the debate about
whether private-sector operators can be trusted to provide social
care. Unions, such as the GMB, are certain the idea is a bad one.
Amanda Gearing, a regional organiser in the West Midlands,
says: "Residential services should be left to local authorities, not
companies with shares listed on the stock exchange. They will
always put profits before people." Labour party stalwarts, like
Michael Meacher, agree.
But Peter Hay, president of the Association of Directors of Adult
Social Services, says: "Not all private care is bad. Private
companies have pumped in £19bn of investment in the last 20
years. You would never have got that from the public sector. Also
standards are getting higher. In 1991, I remember a local
authority home where there were six men to a bedroom and 12
sharing a bathroom. These days having your own room and
facilities is becoming the norm."

But Emily Thornberry, shadow health minister says: "Social care

cannot be left to uncontrolled market forces."

She and others believe better supervision is vital. But

surprisingly, no body in the UK seems to have direct
responsibility for ensuring private care companies avoid risky
business models of the kind that sank Southern Cross.

Health minister Paul Burstow says the new NHS regulator,

Monitor, could perform such a role. At the Department of Health,
officials are working on proposals to require care home operators
to take out bonds underwriting the continued care of their
residents in the event of their financial failure.

These are steps in the right direction, but more needs to be done
because one thing seems sure: without tighter regulation and
better policing, there will be more Southern Crosses.
Corporate care home collapse and ‘light
touch’ regulation: a repeating cycle of
failure

In light of the care home chain Four Seasons going into

administration David Rowland looks at the failure of the regime designed to prevent
such situations, as well as the cause of the collapse. He concludes that the rights of
hedge funds and private equity investors to extract profit from the care home sector
are given priority than the rights of older people to a secure home at the end of their
lives.

In 2011 Southern Cross, the care home chain which housed and looked after 31,000
residents went bust. A combination of the financial crash and high rental payments to
its landlords meant that it was unable to repay the debts that it had accrued in order
to expand the company. The impact of this on thousands of older people and their
families was significant. Although only 3 homes eventually closed, the corporate
collapse led to significant anxiety for the care home residents who were worried that
they might be evicted at very short notice, as is common when care homes close.

When Southern Cross collapsed many of its care homes owned were sold to another
larger provider, Four Seasons Healthcare. In late April 2019, Four Seasons
Healthcare – which currently owns 220 care homes housing 14,000 older people –
also became bankrupt, again causing distress and anxiety to thousands of older
people. It too was a highly leveraged company which collapsed due to income from
local authorities being insufficient to meet the costs of servicing its high levels of
debt, as well as providing care.

The future ownership of Four Season’s care homes is currently unclear and no
decision has yet been taken on how many will stay open. But given that some of its
care homes have already been closed in order to meet debt repayments the anxiety
of residents is justified.

In the 8 years between the collapses of these two major care companies the
government introduced new regulations covering the private care home sector. Yet,
despite this new regulatory framework the collapse of Four Seasons was entirely
predictable. In fact it could be argued that the new regulatory framework made it
more likely that the company would collapse.

The Care Act 2014 contained two provisions to address the issues behind the
Southern Cross fiasco. The first was a requirement that any large care home
provider should be subject to an “oversight regime” by the Care Quality
Commission. Certain care home providers had to provide regular financial
information to the Commission so that it could monitor their financial viability.

Whilst 70% of the care homes in England are small, mainly family-run businesses,
around 30% are owned by overseas investors many of whom view them as assets
for extracting large sums in the form of interest payments, rent and profit. The larger
care home providers which were required to submit data to the Commission under
the 2014 Act are owned mainly by investors and owners registered outside the UK,
some of which are private equity funds, real estate investment trusts or US hedge
funds.

That the task of overseeing this highly complex financial market was given to a
regulator with a remit to enforce care quality standards across the NHS and social
care, and not to a financial regulator, demonstrates just how ‘light touch’ the new
regulation was designed to be. In addition, whilst the Care Quality Commission is
asked to spot the warning signs which may augur a provider collapse, it can do
nothing to prevent it. In fact, although the financial woes of Four Seasons caused
care quality standards in its homes to decline – as also happened before Southern
Cross collapsed – the Commission could not require the company or its owners to
take action to stabilise or improve the company’s financial position.

Thus, whilst the Commission has regulatory levers – although even these are very
weak – to address the causes of poor care in some areas, such as low staffing levels
or poor clinical governance, it has no powers to address one of the commonest
cause of poor quality, namely the financial difficulties of the care home owner. As a
result, the Commission has had to sit idly by over the past two to three years whilst
the collapse of Four Seasons has happened in slow motion and the care provided to
its residents has got worse.

The second aspect of the new regulatory framework contained within the Care Act
was a requirement imposed on local authorities to ensure the continuity of care for
the residents of any care home which had closed due to financial reasons. Whilst
local authorities fund much of the care provided in private care homes, there is still a
substantial proportion which is funded by private individuals.

The Care Act requires that in the event of a large provider collapse local authorities
must also take on the financial responsibility for these privately funded residents on a
temporary basis. In doing so, providers were relieved of the financial burden of
making provisions to maintain continuity of care for their residents in the event that
their company collapsed. This change in the law introduced a moral hazard into the
system: once large care providers knew that the costs of going bust would be picked
up by the state there was even less incentive for them to avoid risky behaviour.

The debt burden which eventually sank Four Seasons – estimated to be around
£500 million and costing the company an unsustainable £50million a year to service
– was loaded onto the company when it was purchased by the private equity firm
Terra Firma. It has since been refinanced several times and the company which now
owns the debt and took control of the destiny of the care homes last year is H2
Capital, a US Hedge fund.
It could be argued that neither of these two investors has the current wellbeing of the
care home residents affected by their financial transactions as their primary concern.
Certainly Blackstone, the private equity firm which owned Southern Cross, and Terra
Firma, the private equity firm which owned Four Seasons, have not suffered unduly
from the collapse of these companies. In January 2019, the Evening Standard
reported that the staff of Terra Firma saw the wage of their employees increase from
an average of £134K a year to £322k, whilst Blackstone made a reported £1.1 billion
from selling Southern Cross.

If the government’s policy intention had truly been to stabilise the care home market
through regulation, the Care Quality Commission could have been specifically
authorised to withdraw the licence to operate of any company that was so highly
leveraged that it was liable to fail. Alternatively, major care home providers could
have been required to pay into a fund which the state could draw upon in the event
that one of them went bust. Or they could have been required – as a condition of
their licence – to hold certain cash reserves so that the long-term viability of the
company was given priority over short-term shareholder returns.

But the intention of the 2014 policy wasn’t to prevent provider failure. It was to allow
it to happen in a way which would cause minimum disruption to the functioning of the
market. Thus, as also happened when Southern Cross collapsed, the opportunity is
now there for a new operator – again funded by high-interest loans – to step in and
pick off any valuable assets from the Four Seasons estate, knowing that the UK
state will act as a guarantor if it too goes under. And so the cycle of highly leveraged
international investors entering the English care home market for short term gain can
start all over again.

There is currently little research on the impact of care home closures on older
people. What is known is that it causes significant distress and can often lead to
premature death. In 2013, the Department of Health quantified the benefits of an
orderly care home closure compared to a disorderly closure. It estimated that if a
care home closed down in an orderly fashion, as opposed to a disorderly one, the
“greater peace of mind” this would give residents would be worth £6,510 to each of
them. It was on the basis of this economic rationale that the light touch regulatory
framework contained within the Care Act 2014 was justified.

Tellingly, no assessment was made of the benefits to care home residents of their
home being completely protected from closure. To have intervened to eradicate
market failure and provider collapse from the care home sector would have meant
prioritising the care and wellbeing of older people over and above the interests of
international financiers.

As things stand, the rights of hedge funds and private equity investors to extract rent
and profit from the care home sector are given greater priority than the rights of older
people to a secure home at the end of their lives.

_____________
Southern Cross-style collapse in care
home market cannot be ruled out,
warns study
Study for Care Quality Commission warns that high provider debts, local
local authority fees and pay rises could lead to "financial crisis"

by Chloe Stothart on August 1, 2014 in Adults, Care Act 2014, Care Work, Inspection and

regulation, Residential care

The older people’s care home market in England is fragile and a Southern Cross-style
collapse of a major provider cannot be ruled out, a report for the Care Quality
Commission has found.
The report, by the Institute of Public Care at Oxford Brookes University, identified a
number of conditions in the market that could lead to another big provider failing, in the
way that Southern Cross did in 2011.
It noted that “very few of the providers and financial advisors we interviewed ruled out
the possibility of another Southern Cross-style crisis”.
The study, The Stability of the Care Market and Market Oversight in England, was
commissioned to inform the CQC’s preparation for its new role of market oversight over
the social care sector in England, from April 2015. This is designed to help prevent a
market destabilising failure by enabling the CQC to monitor the financial position of large
or specialist providers.
Big providers that rent homes in poor areas most at risk
The report examined the markets for older people’s and learning disability care, in the
light of the failures of Southern Cross and Winterbourne View provider Castlebeck,
which went into administration and was sold in 2013 two years on from the hospital
abuse scandal.
The failure of Southern Cross – at the time the country’s biggest care home provider –
was driven by a number of factors: a high rental bill, arising from fact that it had sold and
leased back its properties on terms that involved annual rental increases; under-
investment in homes leading to reduced occupancy levels and hence lower income; high
dependence on business from local authorities, and high levels of debt coupled with high
interest rates on loans.
In the event, Southern Cross’s homes were all successfully sold to other providers,
ensuring continuity of care, but the report quoted commentators as saying that their
rescue was a “close run thing”.
The report found that many of the factors that affected Southern Cross were still present
among some older people’s residential care providers, including high levels of debt,
concerns about occupancy levels and the sale and lease back of care home properties.
It found that the greatest risk to market stability was where a large care home provider
which did not own its properties had a concentration of homes in a limited number of
less affluent areas.
Factors leading to greater instability
With both Labour and Conservatives discussing an above-inflation rise in the minimum
wage, the Bank of England signalling future rises in interest rates and public sector cuts
set to drive further cuts in fees for care providers, the report said these factors could
trigger a “financial crisis” in the sector. This would particularly affect providers with a
large number of local authority-funded clients, large number of low paid staff and high
levels of debt.
It also said there was “always the potential for a Castlebeck type failure to occur” –
where failings in quality lead to a business collapsing – particularly in the learning
disability sector. However, it said there was little evidence of any imminent failure of a
learning disability provider.
Professor Andrew Kerslake, IPC associate director and an author of the report said:
“When we look at the market rationally there are a number of providers for whom the
coming year will clearly be a struggle.”
However the report also said that large scale provider failure is still rare and it was hard
to see how the care market could collapse to such an extent that care was not available
for people who needed it.
Market intelligence should be part of new CQC oversight regime
The market oversight regime is intended to ensure the CQC scrutinises more closely
providers that would be hard to replace if they went out of business. Under the system
the CQC should mitigate the risks or ensure the process of transferring clients to a new
care provider is handled sensitively.
The report’s authors suggested several ways in which the CQC could strengthen its
new market oversight regime, which comes in from 1 April 2015 as part of the Care Act.
Professor Kerslake said the regime could not simply rely on financial indicators because
published accounts are backward looking and some popular financial metrics take no
account of the large amounts of debt carried by some care companies. Also, relying
solely on financial metrics could mean the regime would not be aware of companies like
Castlebeck which are financially viable until they are hit by a scandal and then collapse
fast.
He said the CQC should also use market intelligence such as information gained during
inspections, from care home users, company reports and local authorities. It should also
use formal metrics and be flexible enough to consider the different risks faced by
different companies. He said the quality inspection and market oversight arms of the
CQC should be in close communication because poor maintenance of homes was often
a sign of financial difficulties.
He added: “I would like to see the local authorities and the CQC working more closely
together and sharing market knowledge. Often one of the first people to pick up that
things are not going well is the local authority because they get complaints from people
they fund.”
New skills needed for regulators
The report said the CQC may need to strengthen the role of its relationship managers,
who work with providers, as the job did not did not include skills to financially analyse
company performance or sustainability.
In January, MPs on the health select committee said the CQC did not have the financial
skills to monitor large care providers and that the role should go to foundation trusts
regulator Monitor. But the CQC said quality and financial stability were linked and should
be regulated together.
-