The collapse of Carillion: lessons for company directors

Five years after the collapse of construction company giant, Carillion PLC, its former Chief Financial Officer (CFO) Zafar Khan has been disqualified from acting as a company director, or being concerned in its management, for 11 years. This is just 4 years short of the maximum period of 15 years, reflecting the seriousness of the allegations against him. The Insolvency Service accepted an undertaking from Mr Khan in settlement of its action against him.

Mr Khan did not dispute, for the purposes of the undertaking only, that he caused Carillion to rely on false and misleading financial information for the preparation of the 2016 Financial Statements. This resulted in the material misstatement of profits in relation to the performance of five major construction contracts, which included Battersea Power Station and Royal Liverpool University Hospital. The misstatement was a massive £208.5M which would have shown a year-end loss of £61.7M in contrast with the reported profit before tax of £146.7M. Allegedly Mr Khan used those misleading Financial Statements to justify a £54.4M dividend payment to shareholders on 9 June 2017, just seven months before its collapse.

It also constituted a breach of his duties as a director under section 393 of the Companies Act 2006 and did not comply with International Accounting Standard (IAS) 11, IAS 18, IAS 32, IAS 38 and the IFRS Framework for Financial Reporting.

Subsequently, former group finance director Richard Adam gave an undertaking for an even longer period of 12½ years. In addition to causing Carillion to rely on false and misleading financial information, Mr Adam for the purposes of the undertaking did not dispute that he (i) caused Carillion to procure payments from Wipro in 2013 and 2016 totalling £79M, which were then wrongly reported and accounted for as profits, resulting in an overstatement of profit and understatement of net debt; and (ii) caused Carillion to conceal this information from its auditors.

The remaining directors are also being pursued in relation to the company’s collapse, with a trial set to commence in October this year.

Director disqualification proceedings

Director disqualification proceedings are pursued by the Insolvency Service on behalf of the Secretary of State for Business and Trade. They are based on the misconduct of directors of companies which have failed and entered administration or liquidation and aim to protect the public from the disqualified director repeating such misconduct in relation to other companies. In this case, Carillion held approximately 450 construction and service contracts across Government and had over 43,000 employees. The period of disqualification can range anywhere from 2 to 15 years, with the 11-to-15-year period reserved for the most serious cases such as fraud.

When faced with these proceedings, directors can offer a voluntary undertaking not to be a director, or be involved in the management of a company, as an alternative to being disqualified by a court following a trial, as happened in this case. The Secretary of State may offer a ‘discount’ on the period if an undertaking is provided before proceedings are issued, and will usually not seek its legal costs.

In October 2015, the Secretary of State was given the power to apply to the court for an order requiring a disqualified director to compensate creditors for the loss suffered because of the conduct for which the director was disqualified; however, such orders have been rarely obtained since introduced. It is unclear whether such an order will be pursued in this particular case.

A disqualified director can apply to the court for permission to be a director of a specific company whilst disqualified, although this usually comes with conditions attached. These will depend on the original misconduct and the extent to which they will reduce the risk of further misconduct.

Breach of a disqualification is a very serious criminal offence which can result in imprisonment. The director in breach will also be personally liable for the debts of the company in which they are involved and may face further disqualification.

Guidelines for directors

The Companies Act 2006 is the primary source of company law governing the UK. It outlines the duties of company directors to ensure good governance and compliance with the Act, essential components of any successful business.

Many UK companies are facing challenges, regardless of industry, due to Brexit, inflation, and the knock-on impact of the cost of living crisis. These factors can impact a company’s financial position, as experienced by many, and directors have a duty to recognise and address these problems. Directors should disclose financial problems to shareholders (if applicable), plan ahead and consider the impact of increasing costs, and also cash flow being stretched.

Creditors, liquidators, administrators and litigation funders are increasingly looking to directors to personally compensate the losses of a company which has failed and entered an insolvency process.

Failure to take control of financial issues could see company directors in a similar position to those who presided over the finances and governance at Carillion. Not only could they face disqualification but they may find themselves personally liable to compensate the company and creditors for substantial amounts.

If you are a company director concerned about the financial position of your company, please contact Cory Bebb.