Handshakes Don’t Count: Subcontractor’s Guide to Position For Payment

Doesn’t it seem like there are three phases to most construction projects? — (1) Pre-Construction, (2) Construction, and (3) Lawsuit?

Contractors, subcontractors, and specialty contractors are optimists. They bid jobs regardless of difficulty, location or size. And, when they come in with the lowest bid, they think they are the only bidder who got it right regardless of how much money they left on the table. And to top it off, they’ll sign just about any contract put in front of them, often after their work has started!

As a general contractor who issues more than 500 subcontracts each year, I’m amazed by this. Either subcontractors and specialty contractors trust me completely, they can’t read, or they just don’t want to deal with paperwork.

Mitigate your risk

It’s a very difficult business, with too many moving parts. Subcontractors find themselves at the mercy of the project plans, changes, payment, scheduling, weather, labor, equipment, materials, and deliveries. So much can go wrong. So much is out of your control.

You see the real story on paper at the end of the job (when it’s too late to do much about it). Financial managers can usually pinpoint what caused profits to erode. They see what the project manager has, or more typically, has NOT done, to manage the contract properly. Not paying attention to key contract clauses about change orders, notice, and documentation is one route to eating costs and lowering your profits.

Use contracts

Most of us don’t like paperwork. But contracting is about contracts, and contracts are paperwork! 50 percent of all profits on construction projects are made by managing the contract properly. Your contracts should protect you and define how you want to do business with your customer. Too many specialty contractors will sign their customers’ prepared 5, 10, 15, or 20-page contracts without reading them or having their attorney review them, and without creating project requirements based on the contract.

Send notices on every job

One of the first things to look for in reviewing a subcontract is: What issues require notice?

“Notice” is proper notification to your customer about the change, conflict, incident, accident, or problem, within a specified number of days, and in a specified format (usually in writing). I recommend for project administrators to review each subcontract and prepare a chart of items requiring notice-along with the specific requirements for each. This “Notice and Documentation” chart must be referred to by the project manager, superintendent, foreman, and project accountant throughout the duration of the project.

Here is a sample notice chart:

NOTICE DOCUMENTATION  |   The Perfect Project

*Check your contract, which may have different timeframes required.

A phone call to the owner is NOT SUFFICIENT NOTICE for any of the above situations. Please contact the project administrator immediately to comply with the contract’s written notice clauses with respect to all the above.

Verbal agreements won’t protect you

In our construction business, we use the slogan: “WIN” – “Write It Now!” Subcontractors tend to postpone or delay notifying their customers of conflicts or issues. Or, they may call and inform them, but fail to put it in writing until weeks or months later. Often specialty contractors never put things in writing and then invoice for extra work without proper notice. This creates major problems in collecting for additional and justified time, labor, materials and job costs.

Another saying we enforce is “No VA’s” – “No Verbal Agreements!” Verbal agreements aren’t worth the paper they’re written on. Properly record all verbal agreements in writing and e-mail or fax them to your customer the same day. Confirm these in weekly or regular project meetings and monthly reports. (See article about lien rights when contract is verbal, and not written here: Mechanics Lien Myth: You Can’t File A Lien Unless You Have A Written Contract).

Send a Preliminary Notice

We’re the Preliminary Notice experts. With us it’s fast, easy, and done right.

Do You Document?

Does assembling all documentation, paperwork and information required by the contract to report issues and problems seem overwhelming? Just think: timely, complete, and reasonable.

When you proceed without proper documentation on a potential issue or conflict knowing there may be a problem, you are accepting responsibility for it. The project owner has RWR’s, or Representations, Warranties & Responsibilities, including a reasonable schedule, professional contract management, timely response to contract issues, and proper payment per the contract. The general contractor and subcontractor’s RWR’s include building what is contracted for and specified by the contract documents plus all contract requirements, documentation and notifications. By not documenting project problems and issues, subcontractors can inadvertently shift onto their own shoulders some of the owner’s responsibilities!

If It’s Not In Writing, It Didn’t Happen

As the third phase of construction mentioned above can be a lawsuit, keep in mind it is not enough to have a legitimate claim. You must be above to prove it. Document a situation as soon as the problem becomes known, or at least within the maximum number of days allowable by contract. I have served as an arbitrator for the American Arbitration Association in a number of construction cases. In most contract disputes I’ve evaluated, the problem could have been avoided if the subcontractor had notified the general contractor in a timely manner. The majority of problems occur when subcontractors try to request monies for extra work done weeks or months later, with no timely documentation of the original problem to back up their request. Some examples of situations begging for documentation:

(1) A plumbing contractor proceeds with installing underground sewer using plans that don’t make the exact dimensions of the pipe location clear. The plumber has now accepted the responsibility for poor plans and installing the pipe in the wrong location. Proper documentation of this situation as it occurred, including specific references to the conflicts or omissions in the plans, puts this problem back on the project owner’s shoulders.

(2) A contractor digs a footing, discovers an unforeseen condition, fixes it, then several weeks later notifies the owner they hit an underground structure and spent additional monies remedying the problem and expects to get paid for the additional work. The owner does not have any liability to pay for extra work performed, installed or completed without proper notice, documentation and authorization per the contract.

Your contract will specify how many days you have to notify the owner upon discovery of a differing condition on a job site. Document it, including written proof and photos, show how you mitigated or intend to mitigate the damages, and submit a claim and change order within the number of days specified by-again-the contract!

Financial managers can monitor the documentation procedures that their project managers, superintendents and foreman use on a typical project. Make sure site problems and subsequent changes in project schedules and expenditures are “noticed” and well documented to make your requests clear, understandable, timely, and in the black.

Some Things Never Change . . .

. . . including the realities of change orders in construction. Change orders are not “extras.” They are additions, changes and deletions from the contract scope of work. Somebody changed the scope of work, not you, somebody else. The project owner, architect or engineer didn’t prepare proper or complete plans or specifications. Never give your work away. Your company has a right to collect for additional work and time when somebody else changes or modifies your scope of work or schedule.

The typical scenario, however, goes like this: a subcontractor walks into the general contractor’s office with a list of change orders that occurred 2, 3, and even 4 months prior and asks to get paid for the extra work involved. You can quote me here: “If it’s news, you lose!”

In some cases the general contractor or developer might be soft-hearted and give you some of the money that you request. However, by contract, no monies are owed. Once you are in court you might also find some judges or juries might be soft hearted, but don’t count on that to win your case and get paid.

Two Types of Changes: Wanted and Unwanted

Change orders fall into two categories

1) Owner-requested changes: those requested by the owner, architect, or builder (like upgrades and additions).

2) Constructive changes: those caused by differing conditions, field problems, conflicts, poor plans and specifications, errors and omissions.

Needless to say, those in the second category come about because of unwanted or unexpected problems. They tend to make people unhappy. Unwanted changes present more problems for budgeting, scheduling, and timely payments. Make sure your project manager keeps a log of potential or proposed change orders as well as executed change orders. Match each project’s monthly budget report to the executed change order log to insure an accurate committed cost, estimated final cost and anticipated profit.

For each project, review the project general conditions in the specifications, general contract and subcontract to look for the timeframe allowed to request additional monies and additional time for change orders. The requirements may be different for owner-requested changes and for constructive changes.

While you are required to give notice of occurrences related to change orders, the project work will typically proceed while final change order negotiations ensue. Follow procedures established in the contract, and establish your own management procedures to track these incidents carefully and completely.

Use a Field Memo System

On the job site, a crew hits an underground water line not shown on the plans. With water spraying all over the excavated and open footings, what should the subcontractor do? Wait for a signed change order or take steps to mitigate the damages? Most contracts have language allowing the subcontractor to continue working, fix the problem and keep the job moving. The key is to inform the general contractor or owner as soon as possible. Consult your contract first as project requirements can vary. Always call the owner or contractor immediately and follow up with a faxed field memo no later than by the end of the day. By contract you are allowed a specific amount of time to request more money and time for the extra work and change order.

Remind project managers, and remind them again, to follow up any phone calls or informal conferences with a field memo “noticing” the change, whether it is owner-requested or constructive. Make sure they get the owner to sign it in a timely manner. Make sure a copy goes to the project manager and project bookkeeper so the contract requirements for billing change orders and reporting can be met.

The field memo system is a simple way to get a customer’s signature authorizing you to proceed with your work, and acknowledging that you’ll agree on a price later. The actual change order can involve many parties including the subcontractor, general contractor, construction manager, architect or engineer, project owner and lender. In a typical situation, the subcontractor submits a change order request, the builders’ project manager reviews it and submits a change order request to the owner, the owner has the architect or engineer approve it, and then if it is valid, the bank must approve it so the progress payment cost breakdown application can be processed. Those steps can sometimes take 3, 6 or 12 weeks. The final price of owner requested changes is usually approved prior to starting the extra work. On constructive or unwanted extras, most change orders are rarely approved prior to the start of the work.

Charge the Right Price

Most contracts delineate how to proceed with change orders. There are three standard ways extra work can be performed by contract. In the lump sum method, the owner or contractor can require the subcontractor to perform the work “lump sum” or “fixed price” for extra work agreed on prior to starting the work. With a detailed cost breakdown approach, the subcontractor can be required to present their detailed estimate with backup. If the general contractor or owner isn’t satisfied with either the lump sum quote or the detailed cost breakdown price, they can usually force the subcontractor to perform the work on a cost-plus basis.

Many subcontractors only like to work on a lump sum basis. However, change order prices often seem too high to the general contractor or owner. Charge the right price the first time! I’ve been in business a long time and I know what things should cost. If a subcontractor forwards an extra charge to me in the amount of $750 for a $200 item, and I submit the bill to my customer for approval, my customer will think I’m either trying to gouge them, or I don’t know what things cost. I then have to go back to my subcontractor and tell them to give me a fair price. I now don’t trust my subcontractor, and he doesn’t like dealing with me.

Your reputation is at stake, as well as your bottom line! In most cases the lump sum method produces a higher charge than the detailed cost breakdown or the cost-plus basis. Contractors know this. When a lump sum estimate is rejected, negotiating over price ensues using the detailed cost breakdown method. Agreements begin and enemies are made at this level. Make sure your estimates are right the first time.

Extra Work Takes Extra Time

In every change order request always include the additional time required to perform the extra work even if it doesn’t affect the critical path of the project. Every time you do additional work it takes additional time. No exceptions!

COSTS THAT CAN BE INCLUDED IN CHANGE ORDERS:

• Bond
• Insurance
• Overhead
• Profit
• General Conditions
• Project management
• Supervision
• Truck & Transportation
• Costs
• Temporary Facilities
• Temporary Utilities
• Bookkeeping
• Overtime
• Cleanup
• Tools
• Equipment

Get Everything You Can

As a general contractor, I review hundreds of change orders every year. I often see subcontractor change order requests that don’t ask for everything the contract allows them to get. Look at your contract. Verify what costs can be included in change order requests. Figure 5 lists the costs that are generally allowed and often overlooked. Note that general conditions can usually be included.

WHY WEREN’T CHANGE ORDERS IN WRITING?
A LIST OF EXCUSES…
Excuse #1: “I’m too busy right now to get the signature”
(But never too busy to go to court!)

Excuse #2: “I trust my customer, he seems fair!”
(How many good jobs will you have to do to pay for $10,000 in unpaid change orders?)

Excuse #3: “Don’t worry, I’m friends with my customer”
(Friends sign and pay for change orders, enemies don’t)

Excuse #4: “We’ve got to keep the job moving, I’ll get it later”
(When I have no leverage!)

Excuse #5: “I don’t want to rock the boat this early in the job”
(Training your customer starts at the beginning of the job!)

Excuse #6: “My customer told me we’ll work out all the extras at the end of the job”
(When they are out of money!)

Excuse #7: “I don’t want to nickel & dime my good customer”
(I’d be a rich man, if I had all the nickels & dimes given away!)

AND The HANDSHAKE RULE: “Handshakes Don’t Count!”

Always verify change order markup for overhead and profit in the subcontract, general contract and project general conditions in the specifications. The general contractor and subcontractors are only allowed to charge markup per the contract documents. Often the subcontract markup for change orders does not match the general contract. In these cases, the subcontract always overrides, because a specialty contractor is first held to the subcontract. Financial managers should be aware of the different markup rates for contractors and specialty contractors on each project. Put these on the project checklist when the job starts. If you always use the same rate on every job, you can get burned by a different rate buried in a subcontract after it’s too late.

Determine the project change order markup rate for:

• OVERHEAD
• PROFIT
• LABOR
• EQUIPMENT
• MATERIALS
• SUBCONTRACTORS

A contract may allow a markup of 20 percent for labor, but only 10 percent for materials. Every job and every contract is different. Verify!

Get Wet Ink

A big problem for most construction companies is performing work without signatures on change orders. Everyone knows to get signatures as soon as possible or before proceeding on extra work, but project managers seem to delay this difficult task for several reasons. A slogan I use in my company is, “No WIMPS!” Often a project manager or superintendent doesn’t want to make waves, confront the issue, or push his customer. He or she might have told the customer, “We’ll work it out later.” To me this is the sign of a weak or wimpy project manager, superintendent or foreman. These traits will only lead to lost project profits.

Late Means Never

Late means never, if you know anything about contracting! Another slogan I use is “NNNN”-“No Notice, No Nookie.” You can’t even get to the dance without a ticket.

Some project managers are good with paperwork, and some are not. Those who have a weakness in this area need to be accountable. Those who are overworked need support. Insist on documentation. Ask for details about project problems or tough customers. Help your project team put together the paperwork needed. Go to the customer with change orders quickly and accurately.

Train your customers!

Meet with your customers at the beginning of every project and tell them exactly how you want to business with them. Tell them up front, in advance, you will require signatures in order to proceed with extra work, you expect them to abide by the terms of the contract, and you will stick to it. Play hardball and be firm but fair. Your customers will respect you and treat you professionally. When you don’t require the customer to honor their contract, and go ahead and do work without signatures, the customer then does not respect you or treat you well. Play hardball and win!

The Accountability Department

I call my accounting and finance department my Accountability Department! This is where the all project problems finally surface. Financial managers often don’t get involved in projects on a day-to-day basis. But the financial reports, phone calls and lack of documentation tell the story. Have you ever eaten $100, $1000, or $10,000 at the end of a job because no signed change orders authorized the work? You can get all you deserve by following these solid ideas to insure your change orders are approved, documented and noticed.

CHANGE ORDER MANAGEMENT RULES

1. Change Orders are NOT “Extras”! They are additions, changes, and deletions.

2. Never Give It Away

3. Be Firm But Fair

4. Charge the Right Price the First Time

5. Never do “EXTRA” work without a clear understanding of:

• Is the work extra?
• How is it to be charged? (lump sum, cost plus?)
• Who pays?
• When paid?
• Is there money available to pay?
• Who is authorized to approve?
• Will that person be responsible to pay you?

6. Always include the ADDITIONAL TIME Required to Perform the Extra Work

Summary

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Handshakes Don't Count: Subcontractor's Guide to Position For Payment

Author

Peter Menge

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