A bankrolled action against Carillion’s auditors puts profit before justice

The Royal Liverpool Hospital was due to open in March 2017. More than four years later it remains a building site and a memorial for its original builder, Carillion.

Just as delayed and fraught have been attempts to hold to account those responsible for the collapse of the construction outsourcer into insolvency in 2018. This week the calls for retribution were directed at KPMG, the auditor that signed off Carillion’s accounts for 19 years. Liquidators have secured £250m to pursue KPMG through the High Court on an allegation of negligence, with funds provided by no-win-no-fee specialist Litigation Capital Management.

The use of private litigation financing is unusual for what is effectively a test case. Though there have been attempts in the past to hold company auditors accountable for losses, the action against KPMG is believed to be the first involving a compulsory bankruptcy handled by a court-assigned civil servant known as the official receiver.

Also unusual is the involvement of PwC, which is earning about £50m to run the liquidation on behalf of the Insolvency Service. In effect this is one of the big-four accountants steering a lawsuit against another.

This creep of private investor money will not sit well with those who see litigation funding as a taint on the judicial process. Broad claims of Americanisation have followed criticism of sector heavyweight Burford Capital over its policy of part-booking case values before judgments were delivered.

Though a 2006 High Court ruling allowed external backers into the English legal system, third-party funding is still a relative rarity. The ever-growing pile of investor cash waiting to be deployed raises the likelihood of flimsier actions, however, and regulation for the moment is by a voluntary code of conduct.

Introducing a pure profit motive might encourage defendants to waste court time with delaying tactics that erode the financial backer’s risk-reward estimates and make a settlement more palatable.

Litigation funders scored a rare PR victory last month when the High Court quashed criminal convictions against 39 Post Office staff bankrolled by Therium Capital Management who had spent more than a decade seeking to clear their names.

The case against KPMG does not look so clear cut.

Central is the official receiver’s view that Carillion’s board of directors considered the business “profitable and sustainable” because of a clean audit. Its argument appears to hang on the conceit that the outsourcer’s directors took KPMG’s opinion as a reason to keep dividends and bonuses flowing for longer than they should. Because the auditor failed to flag to the board the company’s own misreporting of contract liabilities and burying of debt through Greensill-style supply-chain financing, it might have to wear the responsibility.

In 2018 a parliamentary inquiry found KPMG “complicit” in Carillion’s aggressive accounting policies because it had failed to challenge management. Complicit does not mean accountable, however. Did the outsourcer’s board really rely on the auditor to understand its own financial reports? Even the most skilled of outsourcers would struggle to pass that buck.

The case of Equitable Life offers a precedent of sorts. In 2005, five years after its near collapse, the mutual insurer abandoned a negligence claim against its auditor Ernst & Young for £700m in damages. Capitulation came only after Equitable’s former directors told the court that EY’s opinion had not affected how they ran the company, which made it difficult to prove the necessary condition that any negligence had caused loss.

Though it’s a fool’s errand to defend KPMG’s role in the Carillion scandal, allegations of negligence look driven more by the legal system’s favourite tenet of following the money than by a desire to hold wrongdoing to account. Third-party funding makes transparent the profit motive.

KPMG is flush, having sold its UK restructuring business in March to private equity firm HIG Capital for £400m, and should have professional indemnity insurance in place to backstop liabilities. Settling quietly to avoid the multiyear court case might be in both its interest and those of Litigation Capital Management, which has reported a case success rate of 95 per cent.

Meanwhile, much like the Royal Liverpool Hospital, the construction of a case for Carillion’s board of directors to answer remains as frustratingly far from completion as ever.