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The Cost Estimator’s Role in Identifying Contractural Risk

Robert H. Pratt, FCPE

The Cost Estimator’s Role in Identifying Contractural Risk

Posted: October 30, 2017 | Estimating

Construction cost estimators are typically the first employees of a contractor or subcontractor to review the terms of a proposed contract on a project under bid. The terms of a contract are essentially the rules governing the process under which the contractor, project owner, architect, and consulting engineers will be obliged to perform their respective roles. These roles continue through the process as a project is bid, awarded, executed, completed, warranted, and managed, whenever circumstances addressed in various contract clauses arise.

Estimators should note that properly reviewing and assessing the risks embedded in the terms of a prospective contract are just as important, if not more so, than the performance of an accurate scope of work takeoff and competitive/reasonable pricing of that work.

Experienced construction cost estimators know the value of studying the provisions in standard industry contract documents, including the AIA A-201 General Conditions Document and the ConsensusDocs® 200 - Standard Agreement and General Conditions Between Owner and Constructor.

Once an estimator has a good understanding of the provisions and terms contained in these documents, he can spot variances much easier – especially when faced with reviewing and assessing the risks of a contract using a non-standard or customized set of terms and conditions.

One of the greatest risks which contractors and subcontractors face when entering into a contract is that they will not be paid in a timely manner after they perform their work. Consequently, standard forms of contracts typically provide for the obligation on the part of the owner to provide reasonable evidence of the financial arrangements he has secured. If the owner has provided substantial proof of these financial arrangements, the contractor can be assured that the owner will be able to fulfill their responsibility to pay for the work performed under the contract.

For example, ConsensusDocs®200, 2017 Edition contains the following:

4.2 FINANCIAL INFORMATION Before commencing the work and thereafter, at the written request of the constructor, owner shall provide constructor with evidence of project financing. Evidence of such financing shall be a condition precedent to the constructor’s commencing or continuing the work. Constructor shall be notified before any material change in project financing.

The AIA, A201™ - 2017 Edition, General Conditions of the Contract for Construction, under §§ 2.2.1, 2.2.2, 2.2.3, and 2.2.4, provides a similar level of assurance to the contractor prior to starting the work. However, after work has started, the AIA has incorporated into its corresponding provisions certain hurdles, additional steps, or criteria, which the contractor must take or encounter before the owner is obliged to provide reassurance of financial arrangements. One of those steps involves the owner failing “to make payments to the contractor as the contract documents require.”

As a forensic expert witness in a variety of construction disputes, I have seen the problems that contractors or constructors and their numerous subcontractors have experienced when an owner failed to meet their financial obligations in the middle of a project.

The reasons for the owner’s failure are varied, including:

  1. An owner's loss of equity in other projects or property used as collateral for the financing of a project, or
  2. Where the owner's construction loan was for only a part of the project's total estimated cost, and the lender has insisted that the owner provide more capital of their own before additional loan funds will be disbursed, or
  3. The owner has experienced an uninsured loss affecting their cash flow and their ability to pay for the work in progress.  

Under such circumstances, it is quite possible that a contractor or constructor and their subcontractors might get drawn out for two or more months with the owner’s promise of a pending payment. During this time, the contractor/constructor and subcontractors may find themselves investing significant amounts of their own resources and funds into an uncompleted project.

An uncompleted project has virtually no market value. Sometimes a contractor’s or subcontractor’s expenditures over two months or more can be the equivalent of their own net worth, leading them into financial ruin. They no longer have the working capital to take on new work that would enable them to cover their costs of doing business. If they don’t have the funds to pay for the labor, materials, and equipment needed to perform work on some other project, they probably don’t have the funds to keep their doors open.

While it’s true that contractors/constructors and subcontractors will typically have mechanic’s lien rights, such rights do not equate to having immediate access to funds. Also, the pursuit of payment via mechanic’s liens requires the expenditure of even more money on attorneys and, sometimes, expert witnesses. It can take months, and even years, to collect on mechanic’s liens. Therefore, an owner’s ability to pay for the work in progress on a project is critical to contractor’s and subcontractor’s financial stability.

Contractors and subcontractors should not have to face a potential dispute in order to obtain an owner’s financial assurances. It usually isn’t the financially strong owners from whom contractors need contractual protection. It is the marginally sound owners or those on the brink of being unsound who necessitate more favorable contract language. Construction cost estimators working for contractors/constructors and subcontractors should be alert to custom contracts that do not provide for any obligation on the part of a project owner to furnish reasonable evidence of project financing.

Construction cost estimators are also encouraged to review the terms contained in the new 2017 edition of the AIA A-201 General Conditions Document. They should discuss this document with their company owners and executives in order to determine for themselves whether or not the modified language in the 2017 edition is creating a more arduous procedure. If financially weak owners would be able to utilize this modified language against a contractor’s interests, it could result in an owner extracting more work or value from a contractor than what an owner can pay. This may temporarily enrich an owner, enabling them to defer payment, but in the meantime, the financial condition of contractors/ constructors and subcontractors may be harmed to such a level that they might not survive or easily recover.

There are many other standard contract provisions which construction cost estimators should review, assess, and discuss with their company owners or executives, especially those published in the latest versions of both ConsensusDocs®and the AIA Contract Documents. Any modifications contained therein, or in any custom documents being proposed, should be evaluated from a risk allocation perspective.

About the author:

Robert H. Pratt, FCPE, is past chairman of the ConsensusDocs’ Content Advisory Council of the Coalition of the more than forty endorsing organizations. He is the representative for the American Society of Professional Estimators. He and his firm are also active in the AGC, ABC, ASA, and the Construction Law Forum of the American Bar Association.