Everyone in the construction industry knows the story.  A project begins and everyone is getting along.  The schedule and scope seems reasonable. Everything is perfect…until the first day of work.

On the one hand it shouldn’t be surprising that things will go wrong on a project. We are all aware of the what can go wrong will go wrong law of nature, but more than this, it’s really an impossible expectation that so many business relationships will go so swimmingly through so much on any given project.  You wouldn’t expect, for example, 100 out of 100 marriages to survive in perpetuity. Divorces happen. Arguments happen. Life and circumstances just happen.

Therefore, the first part of this post’s title is perhaps a bit of an understatement: Contractor failure risks are real.

You probably already know that right? Maybe it’s the latter half of the post’s title that has you reading along here.  The promise that these risks are preventable. Can such a thing be true?

Great Resources on Contractor Failure From All Perspectives Published by Construction Executive

Construction Executive’s Risk Management just published a series of articles about contractor default risks, and what companies can do to mitigate those risks.  These articles are fantastic reads for everyone in the construction industry.  Not only do I encourage you to spend some time reading these articles, but I specifically suggest reading the articles that may not directly apply to you.  In other words, think about the owner’s perspective on contractor default risks even if you aren’t an owner. Understanding the owner’s perspective will empower you to improve your relationships with owners, as you’ll have a bit of a perspective on how to ease the owner’s concerns about you. The following is a summary of some recent articles published in Risk Management:

Navigating A Contractor’s Deteriorating Financial Condition: An Owner’s Perspective
Written by construction law attorneys who likely represent owners in construction disputes from time to time, this article does a good job of promoting a temperate approach to a contractor problem. If an owner senses a contractor in distress, the article warns, do not “rush to terminate…unless it is clear that…[the contractor is] incapable of completing the project.”  The authors fail in underscoring or explaining why this is good advice, but in its place, they give owners good advice on what alternative options they have in the face of a contractor in distress.

Why Subcontractors Fail and What To Do About It
This article, written by yours truly, is written to anyone on the project who hires subcontractors.  Unlike the above article, therefore, it is not written directly to the owner. However, it could relate to both general contractors and subcontractors who hire sub-subs. This article communicates what to do about subcontractor failure by first exploring the causes for the same. This sets up the finish for some advice on avoiding such failure, which is to: (i) promote lien rights; (ii) leverage bond protections; and (iii) have quality pre qualification procedures.

Why Contractors Fail
Connected to the article that I wrote (i.e. Why Subcontractors Fail), this article digs into much greater detail on the question of why contractors fail.  It is written by folks from the FMI Corporation.  The article’s detail may be its devil, as it digs into a high volume of reasons cited for contractor default and failure.

US Construction Dispute Values Triple to 34.3 Million
This article does not address contractor failure head-on, but is a reflection of the indirect consequences of the problem. When contractor default happens, it results in construction disputes. Accordingly, if construction dispute values are tripling, that’s an indication of contractor default problems.  This report is the 4th annual Global Construction Disputes Report from ARCADIS.  While I appreciate the report, the warning that default values have tripled in the past year seems suspect to me. Further, it is suspect that the average dispute amount is $34.3 million.  That is really high, and seems to only measure a select group of dispute scenarios.

Four Building Blocks of Risk Management
Finally, this article is connected to contractor failure because it gives an overview of what can be done to manage industry risks.  Though this article touches on a lot of risks not directly related to contractor default and failure (i.e. safety risks), there are two areas of risk management that are directly on point:  (i) Pre-big job exposure review; and (ii) Contractual risk review.

How To Manage Your Risks When Contractor Default Rates Are Rising

The Construction Executive’s Risk Management spread is quite timely. Contractor default rates are expected to soar in the rebound economy, which has been reported at length in a variety of sources. Most notably, consider the Viewpoints article on ENR in late 2013:  The New Rules of Risk Include an Increased Threat of Contractor Default.

We wrote an article here on the Construction Payment Blog in late 2013 that dug into risk management best practices a great deal. That article is here: Managing Financial Risk when Contractor Default is Expected to Soar.

This article went into detail about why contractor default is happening and increasing in the rebound economy, and gave the follow advice about what subcontractors can do to avoid becoming a statistic:

  • Understand the problem
  • Avoid common reasons why contractors fail
  • Insulate yourself against risk by preparing for the failure of others
  • Keep lien and bond claim rights in tact
  • Rely on strong credit and collection policies
  • Use joint checks, but don’t get burned by them