COMMON CENTS
Minimizing Risk When Subcontracting Work
By Bo Mocherniak
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Risk exists with all organizations and is an inevitable by-product of doing business. Successful businesses take prudent risks and manage those risks carefully throughout each stage in the life cycle of a project. Sub-contracting is definitely one area where rigorous project management best practices can reduce your risk and help you to better manage costs. There are three main objectives that you need to balance when dealing with sub-contractors: the cost, the schedule and the quality of work.
Risk management starts even before the bid process begins. Here are some Project Management best practices that can go a long way to saving you headaches down the road. Before asking for bids, prepare a construction cost estimate for the entire work and use it as a baseline for evaluating subcontractor bids. Then, prepare complete document packages for the subcontractors to use when they are bidding. These early steps can result in more reliable bids, but can also reduce post-contract disputes and even maximize competition among sub-contractors. At the same time, identify any work you intend to perform yourself. This work should be competitively bid with the remainder of the bid packages.
When dealing with bidders, make sure you require disclosure of any subcontractors that may be considered a "related party" and notification of the specific nature of the contemplated transaction. In other words, make sure you aren't comparing bids from two subcontractors who might have made a private arrangement to rig the process. Also, be aware of the risk of a contractor winning multiple contracts for different parts of the project. These situations need to be monitored carefully to ensure that the contractor is not charging overages from one contract to another. This is a particular concern if one contract is fixed price and the other is time and materials (T&M).
You may want to pre-qualify bidders, typically by issuing a pre-qualification statement that includes:
Consider holding a pre-bid conference call to explain the project and bidding process, entertain technical questions regarding the project and distribute bid documents (including plans and specifications).
When it's time to take bids, require certification with each bid submission. This should state that the bid has been prepared without collusion with others and confirms that the bidder has examined all applicable sections of the contract documents, the location of the work to be performed, and is fully informed as to the nature of the work and the conditions of its performance. Also, reserve the right to reject all bids in the event that the project objectives change or if the bid amounts exceed the owner's budget.
Once you have all of this, it should be easier to review and tabulate bids, convene a post-bid conference with the lowest, most responsive and responsible bidders, and ultimately select the best provider. Remember-the lowest bid isn't always the best, especially if it is a T&M contract. Experience with similar projects is also important.
Next, convert the subcontractor bid into a contract and all material quotes into purchase orders. It's a chance to re-analyze all of your subcontractor bids in relation to the entire scope of the project. Make sure to think about specifications for permitting the use of "like products" to avoid cases where the product offered is not of equal quality. Also, if you can, try to lock in material prices for the duration of the project and not just for the 30 days offered in many bids.
Once the project begins, there are always unforeseen changes. Perhaps the owner has requested changes in scope, systems, kinds and quality of materials or finishes, or presents further development of drawings and specifications, or you might have abnormal field conditions, unknown or unforeseen existing conditions, or abnormal weather delays. Change orders can present their own set of risks and problems. Before approving time and material change orders, make sure you are simultaneously collecting cost and production data from the job. Change orders can also be costly because they don't fall within the bidding process, so the non-competitive bid might not be in line with market pricing.
To mitigate risk, make sure all change orders are approved in writing. If a change order is warranted, you should prepare independent cost estimates for the subcontractor change orders since there may not be time to competitively bid the work. Subcontractor pricing should conform to the requirements of the contract. Avoid change orders that reserve the right to pursue later cost claims purportedly because the indirect impact of the change is not reasonably foreseeable at the time the change order is issued. And, finally, no change order should be issued for work that should be funded using a contingency account.
Finally, when the subcontractor work is finished, look over the billing documents carefully: This is often where fraud is caught. Watch for things like unusual, inconsistent or incomplete pay application forms, lack of cost back up and/or field documentation, and missing attachments (lien waivers, certificates, etc.), and make sure to reconcile the final bill with the original bid and contract.
With over 30 years experience with audit, acquisitions, divestitures and valuations, Bo Mocherniak, CA, CBV, provides services to both public and private companies in Canada and the United States. Bo is National Sector Leader for the Real Estate and Construction Group of Grant Thornton Canada, a member of the Grant Thornton International Real Estate Sector Group and past Chair of Grant Thornton LLP. He can be reached at bo.mocherniak@ca.gt.com.
