Financial problems forced an electrical contracting firm out of business in the middle of a Florida condominium construction project. The bonding company then hired a second electrical contractor to finish the electrical work. When the bonding company suspected that that firm was billing them for work that wasn't complete, it turned to San Jose, Calif.-based Rosendin Electric to provide a peer review of the project and investigate the replacement contractor's work. “We had the contract set of documents and the as-built drawings from the original subcontractor, and they didn't quite agree,” says John Koester, regional vice president for Rosendin Electric. “Anytime you are taking over a project in mid-stream, you need to do a certain amount of investigation.”
Rosendin flew a project superintendent and project manager to Florida to photograph each building and create a chart of the completed electrical work. They then wrote a 10-page report to point out which areas of the project were complete. While the replacement contractor billed for 70% of the work, only half was actually done. When the project executives reported their findings to the bonding company, it terminated the contract with the second electrical firm and hired Rosendin to complete the job.
Koester says the electrical work had both obvious and latent defects when they took over the project. “When our people were doing the initial walkthrough, they saw conduits that should have been in the wall stubbed up in the middle of a hallway,” he says. “Later on, when our electricians were energizing some of the circuits that had already been installed, they discovered that conduits were missing. They would put the fish tape into a conduit, and rather than coming up on the other side of the building, it would go in 20 feet and stop.”
The cost of a contractor default. Contractor defaults averaged 10,000 each year in the '90s, according to a study by Dun & Bradstreet. Richard Dyer, a partner with New York-based Thelen, Reid, and Priest Attorneys at Law, says any number of reasons can be to blame. A firm can bid a project at cost, fall behind schedule, or fail to have enough manpower or the right supervision on a job. At other times, an electrical contracting firm may take on too many construction jobs and be forced to walk away from the project. When an electrical firm is unable to finish its work on time and within the budget, an owner or general contractor may declare the subcontractor in default of its contract.
Depending on whether it's a public or private project, a general contractor will then go back to its original list of bidders to find a replacement contractor or rebid the project. And they will almost always pay more money to bring in a replacement contractor to finish the job than the original bid cost of the remaining work. For example, if an electrical contracting firm is awarded a $100,000 contract to wire a school and works for three months before declaring default on a contract, it may have already billed 90% of the total contract. If the project has to be completed by the start of summer school, the construction team must get the project done on time. As a result, the general contractor may pay as much as $50,000 to complete the work even though only $10,000 remains on the original contract.
Time crunch on a construction project. When a subcontractor defaults on a contract, a general contractor will lose time on a project. The insurance company will visit the construction site and investigate the reason for the default, and the general contractor or owner will need to hire a replacement firm. A month can easily elapse between the date the original subcontractor leaves and the new subcontractor is brought on-site. This lag time can place an even bigger crunch on the job schedule. Replacement electricians can then be forced to work long hours or add extra crews to make up for lost time and finish the job by its completion date. “When you have a major sub terminated and you bring someone else in, this process frequently leads to a project delay,” says Frank Riggs, a partner with Smith, Currie, and Hancock LLP, an Atlanta-based law firm. “The general contractor may ask the replacement sub to accelerate the work and work overtime. Now instead of paying basic wage rates, the general contractor's paying overtime rates in addition to possibly higher overtime rates as a result of its lack of bargaining power with the replacement sub.”
The general contractor is often at a disadvantage because it isn't able to create competition for the electrical work, which leads to higher prices. If the general contractor wants an electrical firm to start immediately, it can't approach six electrical firms and try to get the best price for the work. Instead, the general contractor must find a subcontractor that has the available manpower to start work immediately. Because a general contractor will want to hire an electrical contracting firm as quickly as possible, the replacement firm will have some leverage and should make sure that it's properly compensated.
If your firm is called in to serve as a replacement contractor, make sure that you thoroughly review the surety bond for the job, investigate the existing work that's been completed, and take steps to make sure that you will be paid on time for your efforts.
Bonding a project. A surety bond is a written agreement in which one party, the surety, obligates itself to a second party, the obligee, to answer for the default of a third party, the principal. A subcontractor performance bond ensures that the insurance company will still pay the general contractor if the subcontractor defaults on a project. A general contractor payment bond protects the electrical contractor if the general contractor runs into trouble. Dyer advises electrical contractors to only serve as a completion contractor on projects with a surety bond (Sidebar below). Before signing a contract to complete the work on an ongoing project, ask for a copy of the surety bond and review it carefully.
Riggs says while many public construction projects require surety bonds, electrical contracting firms may have to rely on lien laws to protect themselves against any type of payment problem on a private project. When looking at a bond, an electrical contracting firm should evaluate the rating of the surety. “In the last decade, there have been several surety companies that have gone out of business, so you want to make sure that it's a reputable, solvent surety,” Riggs says. “You can't just be satisfied with the fact that there is a bond. You need to look at the terms of the bond because some sureties are writing bonds that offer a lot less protection than you would expect.”
The surety industry has incurred significant losses over the past five years, and it's become more challenging for contractors to get surety bonds. Many bonding companies have gone out of business, which has led sureties to increase prices and limit capacity. In fact, one of the nation's largest electrical contractors, Integrated Electrical Services, has decided to cut back its bonded work and sell units that depend on surety bonds.
Work in progress. When stepping in to serve as a replacement contractor on an ongoing project, an electrical firm must not only ensure the credit worthiness of the general contractor by reviewing the surety bond, but must also carefully document the work that has already taken place on the project, however, this is often easier said than done. Once the concrete has been poured and the conduit runs have been covered up, it becomes even more challenging to evaluate the quality of the original subcontractor's work. To protect its interests, a replacement contractor should exclude from its completion contract any responsibility for defects in the electrical work performed by the original subcontractor so the replacement contractor isn't held responsible for the problems created by the original firm, Riggs says. “You want to disclaim any responsibility for the electrical work that has already been performed by someone else,” he says. “You're not sure how much work has been done and whether or not it's defective. One of the most important things to remember when taking over a construction project is the need to completely and clearly document the work already performed and the work scope for which you will be responsible.”
Rather than assuming that as-built drawings and the original subcontractor's records are correct, the replacement firm must conduct its own investigation. Project managers should make a complete record of the current state of the project by videotaping or photographing the work performed by the original subcontractor. Replacement contractors can also color code a set of electrical plans to show the work that has been performed.
Before signing a contract, a replacement electrical firm must fully understand the reasons for the original contractor's default. If the problems were solely related to abundant design changes or issues with the drawings, it's likely that the second subcontractor will face the same challenges. Delays from one subcontractor can trickle down to the next subcontractor, and as a result, the entire project can get off schedule. On some projects, other subcontractors can be the root of the problem. For that reason, a replacement contractor should try to hire its own subcontractors rather than working with the companies originally hired under the contract. This isn't always possible, however, Koester says. On the condo job, Rosendin had to work with legacy contractors and vendors. “Once you get halfway through a project with a particular fire alarm vendor, you can't make a change,” he says. “You have all the equipment and all the system devices, and they need to all go together.”
Negotiating a contract. To make sure that your electrical contracting firm is properly compensated when serving as a replacement contractor, it's often more beneficial to require a time and materials contract, rather than a lump sum bid contract, Riggs says. He advises electrical contractors to work on a cost-plus basis, which allows them to be reimbursed for their labor and material plus a markup on their cost.
Contractors who are offered a lump sum bid must make a thorough as-built record of how much work has been done and make sure that they're not held responsible for defective work by the original subcontractor. “If the termination happens very early in the project when there's very little work done, an electrical contractor may consider a lump sum [contract],” Riggs says. “If it's in the middle of the job, there are a lot of unknowns. Everyone is in a hurry to get started because the job is already in trouble. There is little time for a thorough investigation of work already performed, so the electrical sub would be smart to ask for a time and materials contract.”
If there's time to develop a reliable scope of the remaining work, then a lump sum contract may be considered, but the price is likely to be high. A lump sum bid contract requires the subcontractor to estimate the remaining portion of the work and then compare it against the labor hours, material costs, and engineering assistance needed for the first half of the project. However, working on a cost plus-basis provided a better value for the bonding company on the Florida project, Koester says. “If we had to give them a lump sum bid, we would not have taken on any of the risk,” he says. “We would have priced the project as high as if we were building it all over again.”
If you're willing to take on the challenge, replacement contracting work can generate a significant amount of profit in a relatively short amount of time. Before agreeing to serve as a replacement contractor, however, you need to carefully evaluate the surety bond situation that exists, create a detailed visual and written record of the electrical work that has or has not already been performed, and try to negotiate a time and materials or cost-plus contract with the general contractor or construction manager. While finishing up another's electrical work can present certain challenges, it can also keep your electricians working and generate additional revenue in a slow moving economy.
Tips to Serving as a Replacement Electrical Contractor
- Ask to see a copy of the surety bond before signing the contract.
- Conduct an early investigation to determine what has been done and what's left to do on the project.
- Discover the cause for the original contractor's default.
- Work on a time and material basis rather than accepting a lump sum bid.
- Spend extra time on documentation throughout the course of the project.
- Ask for advanced payment to finance the mobilization of your electricians.
- Clarify whether you'll be taking on the original subcontractor's subs or whether you will be able to hire your own.