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The weak economy has made it more important than ever for general contractors to vet subcontractors on construction projects, although it has become more difficult in many cases to do so, experts say.
Most project owners and general contractors take steps to pre-qualify subcontractors, assessing financial condition, safety record, insurance coverage and other factors. With the slowdown in new construction, though, more subcontractors are bidding on a dwindling number of jobs, sometimes working outside of their specialties or normal geographic areas.
To hold down costs, more non-government projects also are being “hard bid,” with work going to the lowest bidder, rather than negotiated with subcontractors who might be more qualified or better known to the general contractor.
“In a bid environment, it's hard to do prequalification,” because of time constraints and pressure to go with the lowest bid, said Brian Carpenter, senior vice president with Willis of Minnesota Inc. in Minneapolis.
The need to prequalify is greater than ever, he said, “but the ability to do it has been somewhat impaired.”
While general contractors have always tried to choose subcontractors carefully, they have not always followed a formal prequalification process, relying instead on surety companies to vet subcontractor strength. Since the 1990s, though, formal prequalification has increasingly become the norm.
A key area of prequalification scrutiny is a subcontractor's financial data. General contractors may ask for particular details like annual contract volume, sales and net worth, or may ask for full financial statements.
This can be sensitive, because most construction businesses are privately held, said Brian Harvey, principal with Barnes Dennig & Co. Ltd., a tax and consulting firm in Cincinnati. A general contractor asking for financials should assure subcontractors that the information will be reviewed confidentially by a limited number of people, then destroyed, he said.
In the past year or so, more subcontractors have been willing to volunteer private financial data, partly as a marketing tool in competitions with less financially secure subs, said Luke Nolan, director-construction services group with Aon Risk Solutions in Dallas.
A financial review can spot a variety of red flags, Mr. Harvey said, including too much of a subcontractor's equity committed to a single project; excessive dividends taken by its owners; or significant early billings on a project that aren't accounted for as cash or receivables on the subcontractor's balance sheet, indicating that it has to use the money immediately to cover costs on another project.
Other targets of prequalification review include:
*Safety management history. Many general contractors require that a sub's workers compensation experience modifier be 1.0 or lower, confirming that its loss experience has been on par with others, said Geoffrey Hall, senior vice president with the construction industry practice group at ACE USA in New York. *Prequalification programs also may ask for Occupational Safety & Health Administration data such as illness/injury rates and lost workdays, along with information about a sub's own safety management programs and procedures.
*Insurance coverage and surety bonding capacity. General contractors may require minimum general and auto liability limits from insurers with minimum A.M. Best & Co. ratings, and may want to know a sub's bonding limits even if a surety bond is not required for a particular job.
*Work history, including the type of work done, jobs completed and in progress and disputes over previous work. General contractors also should look at a subcontractor's schedule of upcoming jobs to be sure it is not overextended, Mr. Harvey said.
The focus of a prequalification review can vary depending on the type of work involved, said Tom Grandmaison, executive vice president and construction casualty leader with AIG Property Casualty in Boston. Worker safety has historically been a key focus because work comp injuries have been a major source of construction claims, though work quality has also become important with the rise of construction defect litigation, he said.
Finding subcontractors to bid on projects hasn't been a problem since the onset of the recession. Many projects are attracting double or triple the number of subcontractor bids they had previously, experts say.
This trend has made prequalification all the more important. “In tough times — and we've been through some tough times — you see a lot of contractors looking for work, often outside their specialties,” Mr. Hall said.
“If somebody is a street and road subcontractor, they (shouldn't) go building houses in another part of the country,” Mr. Grandmaison said.
Contractors working outside their accustomed territory also can present problems. “Are they equipped to navigate the rules and regulations of the (geographical) area they're asked to work in?” Mr. Hall asked.
Vetting the growing numbers of subcontractors creates administrative headaches for the general contractor and the sub itself, experts say. In response, one company — Deerfield, Ill.-based Textura Corp. — has created an online database to which subcontractors submit prequalification information. The system is intended to make the information more accessible to general contractors, while saving subcontractors from making separate prequalification submissions with each bid.
General contractors, meanwhile, try to streamline the process by imposing “pass/fail'' tests in lieu of a full assessment of each bidder, Mr. Carpenter said. Such tests — a maximum work comp experience modifier, for example, or a cap on the contractor's exposure across multiple projects to a single sub — can quickly winnow bidders on a project, he said.