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Why should I, a project Owner, care about subcontract default? It is the Construction Manager’s problem!

Thomas Kellogg

In a CM-at-risk or Lump Sum contract, the Construction Manager or General Contractor (CM/GC) has privity with the Subcontractors and is fully responsible for delivering an on-time project. The CM/GC is responsible for managing the project and to cure any Subcontractor defaults that may occur. If the CM/GC fails to meet expectations and/or delivers the project late, the Owner has the contractual right to compensation for damages.

 

Unfortunately, however, it is unlikely that an Owner would recover all damages suffered due to a late delivery. For example, suppose the CM/GC delivers a 30-story apartment 30 days late - entitlement to liquidated damages might be worth only $90,000 to $150,000 while loan carry and lost rents might cost an additional $1 million or more. Even if that Owner filed suit against the CM/GC for additional recoveries, the dispute would take years and cost hundreds of thousands of dollars in legal fees. The Owner, CM/GC, Subcontractors, and Tenants all lose, and nobody is made whole.

 

The good news is that rarely, if ever, are these types of delays a surprise at the end of a project. They manifest themselves over months or years and are the product of thousands of decisions. In most cases, they are heavily influenced by the work performed at the Subcontract level. So, if we can anticipate delays by studying certain conditions and if we can design proactive strategies to resolve these conditions, we can proactively avoid late project delivery and the expense it creates.

 

Under normal circumstances (excluding force majeure impacts like pandemics or war), a delay is not caused by a single factor. A delay is the product of compounded business judgements, operational decisions, financial capacity, and underestimations, as well as those human elements of experience levels, interpersonal skills, and management abilities. Delays seldom follow the conditions by which they were formed and over time, these conditions harden until the state is irreparable and delay is inevitable.

 

A great deal of project delay risk resides with the Subcontracts. The mere nature of the Subcontracting community should not be faulted; however, construction is the work of trades - skilled people using specialized tools to turn materials into structures. About 80% of a typical project’s construction cost is comprised of trade work and over 95% of the personnel on a project are tradespersons. When we consider these numbers, it is reasonable to see that the majority of the project risk resides with the majority of its influence.

 

Recognizing where the majority of the project’s delay risk lies, it is then critical to assess those potentially contributing conditions and employ a monitoring system to provide early warnings. Good assessment procedures study copious amounts of information to determine how likely it is that each Subcontractor will satisfactorily perform their Work. Important questions to ask are: Does this company and its personnel have the right experience and capacity to succeed on my project, at this time, in this market, given everything I know? Does this company have the financial wherewithal to weather a storm and insulate itself from a disruption such that my project will not be affected? If this Subcontractor were to default on this Subcontract – whether they are terminated and replaced or not – what is the magnitude and the reach of the primary, secondary, and tertiary effects that might impact other trades or the project as a whole?

 

Conditions like these deserve attention that is not only thorough, but constant. Micro and macro markets change daily, business profiles fluctuate, and project conditions are extremely dynamic. The conditions that lead to a default in the future often develop over time, and by monitoring these conditions, one can look out for those patterns that suggest trends in the wrong direction. Many of these patterns present themselves years before a default. For example:

 

 

 

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Rather than waiting for a Subcontractor to miss a deadline and focusing on the cure, studying the preceding factors is much more cost effective. The cost of a delay far outweighs the cost of efforts to prevent it.

 

Once one understands these risks and the contributing factors, one can then design risk-appropriate plans to monitor them and can act quickly in the event an impending delay begins to form. It is best for the CM/GC to design quickly deployable short-term solutions in tandem with permanent long-term solutions, or collectively, “off-ramps.” In the event of a default, the CM/GC can use these off-ramps to quickly navigate the project back on track. Additionally, and equally importantly, the risk and cost-conscious CM/GC can more safely engage with Subcontractors that financially support the project’s upside, while limiting the downside risk. In other words, this approach can be a safe way to work with unfamiliar Subcontractors (to the CM/GC or Owner) without relinquishing control of the trade’s success to the Subcontractor. The key to developing a proactive plan such as this is to fully understand the profile of each Subcontract and to develop corresponding appropriate plans that address all labor, material procurement, management, and financial positioning risks.

 

Delays can be extremely expensive, and we will never eliminate them from our industry. As tightly as contracts are drafted, it is rare to be fully compensated after a default or late project delivery. However, a shift in focus to proactive assessment and monitoring of Subcontract risks as well as off-ramp program requirements to mitigate defaults and delays, helps support each project’s financial profile upfront, and also protects project delivery dates. It is, of course, in everyone’s best interest that each project is completed satisfactorily and on-time, every time.

 

 


 


Completely Unrelated Trivia Treasure: The best performing stock since 1925 is the tobacco company Altria (NYSE: MO), formerly known as Philip Morris, which has achieved a 265 million per cent return since 1925. A dollar invested in 1925 would be worth $2.65 million today.

 



 

Maple Insight provides default prediction and loss estimation, specifically focused on delay related damages, for Owners and Developers. We use assessment and re-assessment methodologies to help clients avoid risks, identify risks, and prepare for conditions which might put a project’s delivery in jeopardy.

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