Never too big to fail… and other lessons pharma can learn from Carillion

Here, Mark Tempest, VWV partner in the Insolvency and Restructuring and Pharmaceuticals and Life Sciences teams, looks at the construction giant’s case in more detail and what pharma and life sciences should consider in order to protect themselves.

Carillion's failure is likely to have a significant impact on the many businesses and individuals connected to it — from its employees, hundreds of sub-contractors and suppliers through to individual trades, and across a multitude of sectors. Its liquidation has left a trail of losses on big contracts and accumulated debts of over £1.5 billion. The ramifications will be felt far and wide, not just by those with a direct relationship but also by those who contract with and supply to those businesses, such as recruitment and marketing service providers.

For many suppliers to Carillion, the contract would have been one of their largest, if not the largest. These businesses face an uncertain and potentially catastrophic future. They will most probably be left in the unenviable position of being owed substantial debts (for which they must claim in the insolvency process as creditors and are likely to receive very little or nothing at all by way of a dividend) and a loss of future revenue. At the same time, any recourse normally available to them against a solvent company is unlikely to be appropriate or legally possible.

The reaction of pharma and life science businesses might understandably be to be thankful they are not in the construction industry, or directly connected with it. However, businesses in any other sector can and should consider potential parallel situations within their own industry — there are lessons to be learnt that apply outside of construction.

Points of interest for pharma and life sciences

Turning to the pharma and life sciences sector, why is the Carillion collapse of any interest? Well, first, if further evidence were needed, it shows that no business is too big to fail. CROs, CMOs and other product and service providers have contracts with big pharma that account for a significant proportion of their business. Others supplying products to big retail pharmacy chains, some of whom have been lengthening their payment terms in recent years and paying themselves a prompt payment discount if they settle within three months, are likewise heavily exposed to those trading relationships. A loss of those contracts is likely to have a dramatic negative impact on cash flow and viability of those smaller businesses.

But could a big pharma company really fail? Evidence from other sectors, not just the construction industry, suggests that the answer must be ‘yes’. What if they suffer severe reputational damage from the way a clinical trial has been conducted, or the way clinical trial data has been presented? What if a product on the market leads to multiple claims after a major bout of adverse reactions? Alternatively, what if they suffer a late stage clinical trial failure for a potential blockbuster that leads to a collapse in share price and confidence? Seemingly robust retail pharmacy chains are coming under increasing financial pressure from the government’s pharmacy budget cuts, or they may also suffer a damaging reputational issue such as a failure in the standard of care provided when dispensing medicines.

Businesses need to consider and plan for the insolvency of business partners, however unlikely that may seem. They need to protect themselves and prepare for the worst.

Company directors also need to understand their personal duties (and potential liabilities) in the face of their company’s resulting financial difficulties.

Wise words and practices

It is not easy for a business to manage its exposure to one significant customer. Very often that contract is highly-prized and doing anything that might undermine the relationship is unattractive. At the same time, a large contract may well take up time and resources to such an extent that identifying and establishing alternative relationships is simply not achievable. A lot of businesses will be content to enjoy the benefits of the business for as long as they can and defer worrying about the implications of it disappearing to another day.

Having said that, it is worth reviewing contracts carefully, and regularly. If you supply goods, such as APIs, excipients, finished products or packaging, you should ideally have a well-drafted ‘retention of title’ clause. Such a clause will give you, as a supplier of goods, priority over secured and unsecured creditors of the buyer if the buyer does not pay for the goods and goes into an insolvency process. It should ensure that you retain ownership of goods and give you the ability to reclaim possession of them.

Changes to insolvency legislation and processes mean that many older contracts are often simply not fit for purpose. A well-drafted contract will include provisions governing what is to happen on the insolvency of either party; it should, for example, clearly state whether the contract is to terminate automatically or only at the instigation of one of them.

There is no doubt that there is a limit to what can be achieved through documentation, and if practicable any party entering into a commercial contract should ensure that it maintains a robust credit control system. Where a supplier has any concerns over the financial position of another business it is entering into a trading relationship with, it should also consider obtaining alternative forms of security (e.g., a bank guarantee or letter of credit) and taking out credit insurance.

Finally, any business contracting with anyone — even with a big pharma company or a multiple retail pharmacy chain — would be well advised to prepare for the worst and minimise the potential fallout should the unthinkable happen. This means getting advice from experienced insolvency professionals to review contracts and options available in the event all or a significant part of their revenue dries up, or they find themselves with a large non-collectable debt. A ‘wait and see’ approach will likely mean that a business is ultimately forced into a much more difficult position at short notice with fewer and more limited options. Acting at the outset of the relationship, or before problems arise, is always the best advice.