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Risk Profiles: Subcontractors

In contracting, the use of independent subcontractors is a common place.  General contractors may subcontract anywhere from 10 or 15 percent of the work, all the way up to 90 percent of the work, and in many cases subcontractors will in turn utilize subcontractors themselves.

Managing the risk exposures of using subcontractors is critical, in cases of subcontractor default or failure, project costs typically increase sixty-five percent, which can in turn put the greater project at risk.  There are some basic best practices that should be utilized when using subcontractors, not only for larger construction firms, but even the smaller home builder or home remodeling contractors.

Prequalification

When using subcontractors, it’s critical that processes and procedures be in place to manage the risk of using subcontractors, and it begins with an active prequalification process that might look at financials/D&B reports, safety performance, personnel, references and prior project history when evaluating whether or not a particular subcontractor is one that you would want to work with.

Larger contractors who work with a multitude of subcontractors have in many cases, automated the gathering of information for a prequalification process (here is one example).  Requiring a letter of bondability from subcontractors may also provided added reassurance that their operations have been scrutinized by an independent third party (ie. the surety) for credit worthiness and operational risks.

Contracts

The use of subcontractors requires the use of a subcontract.  While this may seem self apparent, we have encountered a number of occasions over the years where the “contract” amounted to a verbal agreement, a handshake and/or a written quote provided by the subcontractor.  None of these offer the upstream party appropriate legal protections, and such a scenario is asking for a lawsuit or default.

There are many different contract forms, from AIA and ConsensusDocs, to every type of hybrid in between, it’s critical you have a legal professional review these agreements to confirm they are legal and appropriately protect your interest.  Business Insurance Associates Inc. brokers a product called LegalShield, that offers pre-paid legal plans for as little as $ 49/month, providing a mechanism for contract review and development.  For more information on this product, contact our office at info@businessinsuranceassociates.com.

Insurance Requirements

Part of the contract you would have with a subcontractor, would contain insurance requirements.  Each organization should have it’s own standards established, crafted with the assistance of their insurance broker and attorney.  This set of insurance requirements, which is often included as a supplemental document referenced within the contract, should be easy to understand, contain current terminology, and be provided to all subcontractors before they even submit bids.   Asking for insurance coverages or endorsements from thirty years ago that no longer exist, or have long since been written into the ISO form, does not reflect well upon an organizations understanding of insurance and risk.

There must also be a mechanism in place to review subcontractor insurance certificates for compliance, negotiate specific provisions when appropriate, and track renewal certificates.

Whether a general contractor or a subcontractor, you will have insurance requirements passed down from the upstream party, often the owner.  The prime contract will also likely contain requirements that all insurance requirements are flowed down to lower tiered parties, and it’s important that is done.  Don’t provide a lowered tiered subcontractor with your standard set of insurance requirements, if your upstream requires you to flow down something else, the lower tiered parties need clarity.

Insurance requirements should contain required limits, types of coverages required and project specific endorsements necessary to both satisfy any upstream requirements, and to protect the upstream party.  Risk transfer through contract is a well accepted practice, flowing down the risk to the party that has the best ability to control it.

Subcontractor Performance

Subcontractor performance is a critical component of overall project success in many cases.  The objective of the prequalification process is to mitigate the risk of subcontractor failure, and having contracts that appropriately transfer risk can help protect a company in the event of a subcontractor related property or bodily injury claim, but short of having subcontractor surety bonds or subcontractor default insurance, your sole recourse may be a little bit of retainage and the legal system, which can be costly in terms of time and money.

Alaska House Bill 79

In late 2018, Alaska House Bill 79 was passed into law which contained important workers compensation reforms, notably establishing a criteria that must be met for the use of independent subcontractors.  To obtain a copy of our whitepaper on this topic, send a request to info@businessinsuranceassociates.com.  This document has important information for anyone using subcontractors.

Summary

When a subcontractor does default, it costs on average 65% more to complete the work they were contracted to perform.  Half of that cost is related to additional costs related to physically completing the work, 21% related to correcting poor quality work already done, and 12% to unpaid lower tiered subcontractors.

If you utilize subcontractors, it’s critical that you (1) use formal contracts, (2) prequalify your subcontractors, (3) transfer risk through the contract and insurance requirements, and (4) manage those subcontracts diligently.  The overall success of your project depends upon it.

For more information or to request an audit of your subcontractor processes, contact our office to speak to one of our risk management professionals.