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    Six Ways Contractors Can Minimize the Risk of Subcontractor Default

    One of the biggest risks general contractors and construction managers face is the risk of a subcontractor default. A subcontractor’s failure to perform can add cost, delay a job, and worse, damage the reputation of a contractor and owner. Not all defaults are preventable, but sound management practices can reduce the risk of default. First and foremost, selecting the right subcontractor is the best chance for success. Here are some key areas contractors should consider and address when selecting subcontractors.

    Financial Review – Subcontractor insolvency is the single biggest cause of default. According to industry insurance firm Zurich’s report “Managing Subcontractor Risk in 2012,” 53% of defaults are caused by insolvency. Getting timely, audited financial statements from subcontractors and using standard objective metrics to evaluate potential subcontractors is a key step in the process. There are many areas of a subcontractor’s balance sheet that are important to review, but consider paying extra attention to a subcontractor’s cash position. Without adequate cash, one slow-paying owner or general contractor on another job can cause a subcontractor to struggle.

    Capability and Experience -Does the subcontractor have experience with jobs of a similar size and scope? Have they worked in the local market before? Subcontractors working outside their normal territory do not know the labor force, local laws and common practices. These are things that can lead to performance issues.

    Historical Performance -How well does the contractor know this subcontractor? If they worked together before, how did it go? Is this information shared from one project team to another? Work only with subcontractors that performed well for trusted peers.
    Continual Review – Many firms use a pre-qualification process to select sub-contractors, but subcontractor qualification is not a one-time event. It must be done continuously to be valuable. Consider refreshing reviews at least annually, and more often for critical scopes, new subcontractors or any scopes a contractor can identify that have a heightened level of risk.

    Exposure Limitations – Qualification is an inexact science. Even the best qualification processes will not prevent all defaults from happening. So it’s important to consider limitations on exposure for any one job (single-job limits) and on a given subcontractor across all jobs (aggregate limits).

    Early Warning Signs – Zurich notes to following early warning indicators of possible subcontractor defaults:
    • Difficulty processing contract documents; providing timely, accurate and complete submittals
    • Increased levels of change orders
    • Frequent and unanticipated supplier turnover
    • Fluctuating workforce size and morale without a scope-related cause; frequent management and labour resource issues
    • Reduced lines of credit
    • Consistency of surety relationship, including quality of bond language and viability of surety provider

    Putting a consistent and objective subcontractor management process in place will significantly reduce the risk inherent in subcontractor relationships.

    Zurich Report: http://www.buildsafe.org/documents/Zurich-Managing-Subcontractor-Risk.pdf