Tuesday, July 9, 2013 Recognizing, Shifting, and Mitigating the Risk - - PDF document

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Tuesday, July 9, 2013

Recognizing, Shifting, and Mitigating the Risk of Subcontractor Default

Presenter: Steve Nelson, SureTec Insurance Company. snelson@suretec.com

Avoidance/Prequalification/Continuous Qualification

• Prequalification and Continuous Qualification of the subcontractor and the

subcontractor’s capacity and capabilities vis a vis the project

• Who does it? Are they qualified?
• Centralizes v. Decentralized?
• Consistently and systematically applied?
• Are the prequalifiers empowered to say “No”?
• Regular and continuous review
• Surety-style financial analysis a proven indicator of performance and likelihood
• f failure, with particular attention to
• Significant swings in profit (or lack thereof) year over year
• Change in backlog
• Negative net cash position
• Increase in A/R aging
• Under/Over billing
• A/P aging
• High utilization or non-renewal of credit facilities
• Loans to/from shareholders
• Distributions to shareholders
• Change in surety
• Evaluation must be considered in relation to scope, complexity, schedule, and

geography

• In addition to financial, consider ethics/character, litigation history, public

filings, credit history, reputation

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• Attention to job cost breakdown, pay items, front end loading, percentage

completion on draws---front end, and as work progresses

Warning Signs

• Recognize warning signs and act!
• Delays in providing prequalification information, bonds, or insurance
• Bid spread
• Financial stress/availability of working capital/lines of credit
• Overbilling
• Increased change order activity
• Competing creditors
• Subcontractor/supplier payment notices, pre-lien, stop notices
• Inquiries/directives from lenders/factoring companies/sureties
• Labor/Supplier/Subcontractor turnover
• Project level management/superintendent turnover
• Death/disability of owner
• Turnover of key management personnel (who often have a sense of impending

problems and are looking for better opportunities)

• Fluctuating workforce/change in crew size
• Low productivity
• Decline in quality of work
• Decline in attention to safety issues
• Difficulty with back office operations – paperwork, submittals, lien releases,

change orders

• Problems/disputes on other jobs
• Negative feedback from other subcontractors
• Understand the financial/operational weakness and tailor the tool to the

problem; i.e., joint checks won’t fix a bid bust or low productivity, increased retainage or withholding payment won’t help a cash flow problem

• Manage a default to minimize exposure

Credit Enhancements

• Subcontract performance and payment bonds
• Subcontractor Default Insurance
• Letters of Credit

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• Personal /Parental/Affiliate Guaranties
• Third Party Guaranties
• Major Supplier Guaranties
• Pledge of Personal Property/Real Estate as collateral security
• Bonded Sub-subcontractors with dual obligee riders
• Hybrid risk sharing
• Shared with owner, surety, or third parties if subcontract award is political,

sole source, or “must hire”

• shared with owner by negotiated right to charge some or all of subcontract
• verruns as cost of the work/change order

Control of Subcontract Funding/Cash Flow

• Dedicated GC employee oversight/mentoring – someone in the GC organization

needs to take “ownership” of the subcontractor’s performance/success

• Joint Checks
• Funds Disbursement Control / Escrow
• GC direct pay of suppliers, equipment, and/or labor
• Increased Retainage
• Reduced Retainage
• Semi-monthly/weekly payroll advance
• Greater attention to job cost breakdown, draw schedule, line items, front end

loading, stored materials, and percentage completion on draws

• Paying more than the subcontract amount, even when not justified by contract,

may be better than a default

Manage the Problem

• Dedicated GC employee oversight/mentoring – someone in the GC organization

needs to take “ownership” of the subcontractor’s performance/success

• Establish processes to recognize warning signs, report, and react
• Act quickly
• Supplement vs. terminate
• Document actions and preserve rights