Reasons Why Subcontractors Fail

Reasons Why Subontractors Fail - Arnold Insurance Agency Blog.jpg

Subcontractor default is a problem that is neither understated nor under-reported. Everyone in the industry is familiar with it and the consequences of the likely, yet always surprising, situation when a subcontractor goes into default on a project.

Therefore, it is more important now than ever to review why subcontractors fail, and what everyone else should be doing about such failures.

Managerial problems

  • Inadequate accounting, financial or project management systems

  • Management or personnel changes or complications

  • Business strategy changes

  • Rapid over-expansion and growth

  • Poor owner, lead contractor or project selection

Labor and material problems

  • Shortage of labor and materials

  • Unrecovered cost escalations

  • Tariffs

Uncontrollable factors

  • Lead contractor on a different job does not pay

  • Severe weather hindrances

  • Unexpected economic failures

  • Difficult contract terms or working environment

  • Changes in the job site conditions

  • Death, illness or departure of necessary employees

  • Labor shortages or difficulties

  • Material and equipment shortages or price increases

Financial signs of failure

  • Tight cash flow

  • Receivables turning over slowly

  • Bills are past due

  • Vendors demand cash on delivery (COD) for supplies and materials

  • Bank lines of credit are borrowed to the limit and credit

Business plan problems

  • No contingency plans, goals or objectives

  • No road map for future plans

Project management problems

  • Inadequate project supervision

  • Inability to find reasonable prices on change orders or inability to collect on change orders

  • Projects are not completed on time

  • Projects are moving at a slow pace

  • One or more projects has a claim

  • Safety violations on the jobsite

Poor estimating and job cost reporting

  • Revenue and profit margins decrease

  • Operating losses

  • Loss or reduction of bonding capacity

  • Contractor bids low to get new work out of desperation

Communication problems

  • Lots of disputes between the contractor and project owner

  • Poor communication between management and field workers

Loss of loyal customers

  • Contractor cannot fulfill contracts – jobs are not done in time or within the established budget

  • Establish a good relationship with your producer and surety underwriter

  • Manage growth and control overhead

  • Communicate with the surety if and when problems arise

  • Understand contracts and their language

  • Read bond forms and look for difficult or unmanageable terms and conditions

  • Verify the surety’s licensing abilities by checking with the state insurance department

  • Develop a solid relationship with the surety and remain respectful of their decisions and practices

  • Use a construction-oriented CPA

  • Have a bank line of credit available to support your business plans

  • Conserve capital

  • Adjust your overhead

TOP THREE WAYS TO HANDLE SUBCONTRACTOR FAILURE

The failure of a subcontractor can be sudden and can cause vast problems. Therefore, the question is whether anything can be done about it. Here are the top three ways to protect against subcontractor failure.

  1. Lien rights. Though this one doesn’t apply for those at the top of the chain (general contractors, owners and lenders), it is still the number one protection measure because of how enormously effective it is for all of the other affected parties. In fact, it is even effective for the defaulting subcontractor, as it can put it in the best position possible to claw its way out of a bankruptcy proceeding. Lien rights protect a company’s right to get paid for work, and more importantly, prevent companies from being placed into the back of a payment line. A subcontractor in the front of the payment line avoids cash problems, and is insulated from others defaulting on the project.

  2. Surety bonds. Subcontractors can obtain performance bonds and payment bonds, and it’s common for general contractors, owners and lenders to require some subcontractors to acquire these bonds. When a subcontractor has these bonds, a default is less burdensome because the surety bond will compensate the affected parties for the losses.

  3. Prequalification. Prequalification often is used by top-of-the-chain parties to assess the likelihood of failure by a lower-tiered party (i.e., a subcontractor). It also can be used by lower-tiered parties to assess the problems that might arise by higher-tiered parties. Everyone is affected by default and should do preliminary analysis to avoid the same. Examining the ability for a subcontractor to deal with the expected cash flow challenges is a necessary evil in today’s construction economy. Also, it serves everyone well to make sure the subcontractor is also taking measures to protect lien rights. If not, the subcontractor is going to be in the back of the payment line, and the result is a heightened default risk.

We can help protect you from all the issues that come from subcontractor failure so please give Arnold Insurance a call and get started building you plan against subcontractor failure. 614-863-0455