Most contractors are resilient, riding the ups and downs of the economy and doing whatever it takes to survive. This sometimes includes taking on low-margin or even no-margin projects just to keep the cash flowing and their employees working.
Now that the COVID-19 pandemic has put the construction industry, like many others, into a tailspin, some contractors will be faced with the decision of whether to take on a job that seems riskier than normal. No construction job is without some uncertainty, but there are some red flags that construction firms should recognize and evaluate, making the choice of whether to accept a borderline project at least a more educated one.
Bad owner reputation
Meeting the owner’s expectations is key to a successful project, but not all owners act in good faith or have the experience to drive a favorable job outcome.
Mark Himmelstein, attorney and partner in the Newport Beach, California, office of Newmeyer & Dillion LLP, said contractors should perform due diligence before signing onto for a project, particularly if the owner has a less than stellar reputation or is an unknown quantity in the building community.
“You’ve got to know more about the people you’re going to do business with, and so you’ve got to do some investigation to understand who they are,” said attorney Edward Seglias, partner at Cohen Seglias Pallas Greenhall & Furman PC in the mid-Atlantic region.
It is important to confirm, Seglias said, that an owner is not at its “first rodeo.” “Do some investigation,” he said, ”to understand who they are, what they’re capable of doing, what their history is so that you can get a comfort level moving forward.”
A search for lawsuits between the owner and previous contractors, as well as for mechanics’ liens, Himmelstein said, could shed some light on whether the owner gets sued frequently and how a future relationship could unfold.
One of the first things to look at, Seglias said, is how well the owner has organized and planned the project. For example, the owner should be able to provide a complete, approved set of drawings along with up-to-date specifications.
“[If] they appear to have either too many inconsistencies or omissions in the information that is provided,” he said, “then that might be a reason to say, ‘This project isn't for me.’”
An incomplete set of project documents, the attorney added, could be an indicator that the owner is expecting the contractor to fill in the gaps, and “those gaps typically cost money.”
Another consideration, Himmelstein said, is the experience and availability of the architect, the owner’s construction manager or other designated decision-maker on the project.
Not only is it important to be able to have ready access to the individual who can deliver timely decisions regarding items like project change orders, submittals or shop drawings, he said, but it’s also important that the individual have the necessary experience.
For instance, Himmelstein said, is the point person’s experience in custom homebuilding but the project for bid is a 12-story apartment building?
The bottom line, Seglias said, is that contractors don’t typically have time to hold the owners' hands and show them the ropes, which is what could happen if the owner and its representatives don’t have enough knowledge about how to manage the project.
“That’s not the business most general contractors are in,” he said. “[Contractors specialize in] executing a plan that’s been organized and well-thought out.”
Contractors need to make sure that money is available to pay for the project, and that could include hiring someone to do a proper investigation into the owner’s finances, Himmelstein said.
“It’s certainly worth doing for a project of any magnitude,” he said.
If the right to verify financing is not in the contract as it is in standard forms like the American Institute of Architects’ A201-2017 General Conditions of the Contract for Construction, then contractors should make sure it is included — and stays there.
It’s not uncommon, said attorney Deanna Koestel with Norris McLaughlin in New York, that some owners will try to have the right for contractors to verify financing removed from the contract. Those owners encompass those new to the industry and those who just don’t believe the contractor is entitled to the information.
“There's no reason not to provide that information because it does provide the contractor some security that there is a bank or a lender or somebody who is going to ensure that they get paid,” she said.
Contractors should keep in mind that in agreements like the A201, they have the right under certain circumstances to not start work or stop work if the owner does not provide proof of adequate financing.
Unfavorable contract provisions
When it comes to contracts, Himmelstein said, it’s all about understanding the risk.
For example, if the owner makes the contractor responsible for all conditions, known or unknown, visible or not visible, the construction firm must decide whether that’s a risk it is willing to take, he said.
An alternative to stepping away from the project in that situation, Seglias said, would be to raise the price or to negotiate unit pricing to compensate for the unknown.
“Any time the owner says, ‘”You take all the responsibility,’ that ought to perk up the antenna of a contractor. It’s the developer’s project. The developer should be assuming those risks.”
No matter if some provisions are part of standard agreements, like the requirement to move forward with extra work without a signed change order, Himmelstein said, contractors shouldn’t shy away from trying to negotiate more favorable terms.
Taking over for another contractor
Taking over a project when the original contractor has been terminated or has walked off the project can be tricky, Koestel said.
“It’s really challenging to carve out anything in the contract to protect the general contractor from taking over liability for the entirety of the work,” she said.
The first thing a construction company needs to determine before deciding to take on this type of project is why the first contractor is no longer on the job, Koestel said. For instance, was the separation due to the former contractor not performing sufficiently under the terms of its contract or was it because the owner stopped paying?
If it’s the latter, and the new contractor feels comfortable assuming the risk, she said, it should try to include a contractual provision that allows it to stop work if it's not paid on time.
Regardless, contractors should be specific in their contracts about what work they are taking on, what work has been completed by the previous firm, and how they will limit warranties and owner indemnification.
In a perfect world, Koestel said, there would be clear stop and start points, like the new contractor coming on board to complete only the interior of the structure, but that rarely happens unless it is planned in advance.
Although all these points should be considered red flags, they’re not necessarily deal-killers unless the contractor and the owner cannot come to mutually agreeable terms.
“If the owner is not willing to [negotiate], he may not find a contractor who's willing to do the project,” Seglias said. “At some point, economic curcumstances ... are going to compel the owner to assume those risks or at least negotiate with the contractor about how to address them should they arise.”