BY NEIL B. CONNELLY, ESQ., BROWN GRUTTADARO GAUJEAN PRATO, LLC
Business is slow. Nothing is in the pipeline and there are a few jobs on the horizon. Then, miraculously, an RFP pops up. It’s right in your wheelhouse, but you know there will be a lot of bidders. What to do? You cut your margin to the bone. After all, you need the cash flow. Without it, you cannot make payroll and you will lose your key personnel. So you lowball the Project, submitting a bid with what you hope is a 1 percent profit margin.
What happens? The job begins fine. You make it through the first few requisitions. Your subcontractors (who are also hungry for the work) are meeting their commitments, and the job is going according to schedule. Then, horror of horrors, delay. There is a strike in the Venezuelan copper mines, causing a shortage in available copper wire. Your electrician can’t get wire on time, and you lose a month on your schedule. Time is of the essence in the contract and there are no damages for delay. You ask for, and get, time, but no money.
Your monthly job overhead for insurance, job trailers, supervisory personnel, and the like, continues at their usual pace, without interruption. They eat into your thin profit margin. Then, another delay. The plumbing subcontractor, who also took the job on a thin margin, can’t pay the higher price for copper pipe, and defaults. Without the plumber, the project falls further behind. Your costs continue to accrue while you scramble for a replacement plumber, but, naturally, his price is much higher than the defaulted subcontractor. By now your thin profit margin is completely gone, and the threat of liquidated damages is looming. You are tapping into your line of credit and it’s nearly maxed out. With personal liability to the bank, you are afraid that your years of hard work are about to come to naught. You start missing payments to your subcontractors, and the surety is receiving notices of claim. Project default is on the horizon.
The above scenario is all too common in the construction industry. It develops from the misconception that a construction company is like a shark, that is, it must always be moving forward or it will die. That false analogy has brought many successful businesses to their knees.
How to avoid the trap? First, don’t take a job solely for cash flow. You are virtually guaranteeing a losing proposition by doing so. Better to price your bid correctly than to undercut the competition and lose money. Keep in mind that you will be held to your bid, and if a surety bond is required by the owner, the indemnity agreement you signed with the surety is a very onerous agreement. Most indemnity agreements call for personal liability on the owners and their spouses. All of your personal assets are, at risk.
If you are already in the soup, with default looming, there are only a few things you can try. As difficult as it may be, the contractor must look to slash its office overhead. Terminating long term employees is painful, but may be necessary if the company is to survive. Any perks, such as cars, unnecessary insurance and the like, must go, the earlier the better. Such actions are, of course, only a small step, but they can set a tone of “all hands on deck,” and any increase in efficiency will be beneficial.
The next difficult step is to go to the project owner. You must lay your problems on the line, holding nothing back. After all, you are asking for financial help that the owner is not contractually required to provide. When going to the owner, you must look closely at the language of your contract. There may be terms that give the owner discretion to issue a change order where delays occur that are beyond the contractor’s control. Even then, an owner’s discretion may be limited by its relationship with the lender. On many, if not most, current construction projects, the lender has become a virtual partner with the project owner, and the lender often has no sympathy for (or experience with) the problems on a construction project. Even if your requests for assistance from the owner are fruitless, your openness with the owner can be beneficial if there is litigation down the line. A judge or jury may find that an intransigent owner, who knows of the contractor’s predicament caused by matters beyond its control, is entitled to little sympathy when the owner seeks recovery from the contractor or its surety.
If there is a surety on the project, you can also ask for its financial assistance. Again, it is absolutely necessary that the contractor facing default be absolutely open and honest with the surety. You will be asked to confirm the obligation assumed by the indemnity agreement you and your spouse executed. You will also be asked to pledge assets, and in certain circumstances to liquidate those assets in order to fund the completion of the project. The earlier you take these steps, the better. If the project is still moving forward, the surety is more likely to consider funding the completion of the project through its original contractor/bond principal. If a project shuts down, the costs to complete skyrocket. Call for a jobsite meeting, bringing all necessary parties to the site including the owner, its lender, the surety and the key subcontractors. Don’t look for sympathy. At that meeting, it is imperative to reach an agreement that results in completion of the project. When the work has been completed, it is much easier to make deals with an owner who can now make use of his completed project, with a surety who has capped its exposure, and with subcontractors who have also limited their expenses and liabilities.
Finish the project, if at all possible. With the project finished, your options increase. You may be in a position to take on a profitable project. You can make deals with your subcontractors to pay items over time, and the same can be true for the surety. On the other hand, with the project incomplete, damages continue to accrue and will often spin out of control. The end result is bankruptcy all around.
The moral of the story is to be careful what you ask for. Taking on a project at any cost so that you can maintain cash flow can often be just that: any cost. Every experienced contractor knows that on every construction project there are unanticipated problems that arise. There has to be a sufficient margin in every contract price to survive the ups and downs in the construction industry.
Neil B. Connelly, Esq. is with Brown Gruttadaro Gaujean Prato, LLC. He may be contacted at 914-523-1297 or firstname.lastname@example.org.