Under the current financial circumstances, it is wise for all owners, contractors and subcontractors to review the rules for crisis management on troubled construction projects. Below, we present three rules of thumb that can help keep a troubled project from turning into a full-fledged disaster.
1. Know the Early Warning Signs
Some warning signs on a project are more visible than others, but almost all share a common characteristic. That is, they signal an impending breakdown in the flow of money through a project and/or the inability of one or more participants to perform their obligations. There are several readily observable warning signs:
- Falling manpower: A daily manpower count can tell volumes about the health of a project. Inadequate levels of supervision or deficient staffing in one or more of the trades is a sure sign that a project is headed for trouble. A decrease in manpower is often one of the first symptoms of deep-rooted and less visible problems.
- Late deliveries: Like falling manpower, chronic late delivery of material or equipment is frequently a sign of worse problems to come.
- Slow-down in the submittal process: Delay in providing submittals can be a signal of problems among the lower-tier subcontractors. Slow-downs in the submittal approval process can signal difficulties within the design team that can have a ripple effect through the project.
- Poor workmanship: An increase in failed test results or project inspections can signal deeper problems related to quality of the workforce and supervision, as well as the financial health of the contractor and subcontractors.
- Schedule slippage: Frequent schedule updates and rigorous comparison to the as-planned schedule will identify schedule slippage before it becomes a major problem. A subbing schedule is often a result of the factors listed above.
- Dropping productivity: Like its close relatives, falling manpower and schedule slippage, a decrease in productivity can be a symptom of deeper problems with the contractor or its subcontractors.
- Failure to meet draw schedule: Failure of the contractor to submit a complete and timely draw request, or failure of the owner to pay in a timely manner, are both red flags that should be heeded by all parties.
- Unclean or unsafe jobsite: Lack of attention to detail, such as clean-up and safety requirements, is sometimes a signal that a contractor or subcontractors are distracted, over-stressed or under-staffed.
2. Avoid the Symptoms of Default and Abandonment
The visible warning signs listed above are often symptoms of the root causes that lead to project default and abandonment:
- Interruption of the payment stream: Money is the lifeblood of all construction projects. A steady flow of cash from lenders to owners, from owners to contractors and from contractors to subcontractors and suppliers is essential if a project is to be completed on time and within budget. Many different circumstances can interrupt this payment stream. Some of the more common causes include a loss of confidence, an inability to obtain funds, an inability to perform or even diversion of money to other projects. If any of these occur, immediate steps must be taken to prevent the project from slipping into deep trouble.
- Difficulty on other projects: Projects can be dragged down by difficulties experienced by the owner, contractor or subcontractors on other projects far away. Resource drain from other projects, or financial problems on another job, is among the most common causes of non-payment, default and abandonment.
- Industry-wide problems: Escalating costs or shortages of material and labor can manifest themselves as problems on numerous projects simultaneously. The result can be falling manpower, late deliveries, delayed performance and cost overruns. These problems can quickly derail an otherwise healthy project.
3. Develop and Follow an Action Plan
Particularly in uncertain economic times, all parties must respond immediately to the appearance of any of these warning signs. Developing an action plan, and detailing how the warning signs will be addressed before they appear, is a proactive means of preempting project failure:
- Update lien waivers: The lien waiver requirements of the contract should be checked, and all lien waivers should be current. If a pattern of waiving the requirement of lien waivers has been established, steps must be taken to revoke the waiver, and the requirement for lien waivers must be stringently enforced going forward.
- Review “open book” and financial disclosure rights: Contracts should be reviewed for “open book” disclosure requirements or requirements regarding financial arrangements such as Section 2.2.1 of AIA Document A201. Such provisions can be used to obtain valuable information about the financial health of the other parties and the project.
- Check payment and retainage rights: Once warning signs appear, the rights of the parties to withhold retainage and disputed payments becomes paramount. Care should be applied in exercising rights to withhold payment, since a flow of funds is required to sustain continued construction activity. At the same time, parties should exercise their contractual rights in a prudent manner to make sure their financial interests are protected in the event of abandonment or termination.
- Verify the dispute resolution process: Many contracts contain detailed dispute resolution clauses with time limits for notices, mandatory stair-step negotiations and other dispute resolution mechanisms. All parties should be aware of the consequences of failing to comply with these requirements. Use of informal dispute resolution mechanisms can also provide an effective means for exchanging information and resolving small problems before they become big ones.
- Call on experts and professionals as needed: If it becomes clear that a project is headed toward a rocky landing, the parties might benefit from the advice of experts and professionals to work through the issues at hand. For example, a scheduling expert can help to find ways to mitigate the damaging effects of delay, and other subject-matter experts can often suggest fixes that are more effectively implemented mid-stream than after the fact.
- Check bonds and insurance: The status of all relevant bonds and insurance policies, and in some cases the financial health of their issuers, should be checked. The project benefits whenever the parties can cooperate to move risks to an outside insurer.
- Review contract terms and conditions: This is often a good time for someone to take the time to read the applicable contract documents from beginning to end. Frequently, there are requirements built into the contract — relating to substantial completion, defective work, indemnities, staffing, recovery schedules and the like — that, if exercised in a timely manner, can mitigate the adverse effects of the “warning sign” events described above.
Even in the best of times, construction projects present many unexpected challenges. When times are uncertain, it is even more important to have an action plan, and to follow it when warning signals appear.