The construction industry invests considerable time and effort to develop and improve practices for planning, commencing and executing construction projects. Much less time is devoted to understanding what happens when a project is suspended or terminated. But in today’s economic climate, many projects have been suspended or terminated, or are at risk of a similar fate in the near future.
What happens when a project is suspended? Mike Clancy, a consultant with FMI, discusses risks and solutions with Dan Murphy, vice president of construction services for Zurich in North America, and Billy Miller, assistant vice president for field operations/construction at Zurich Services Corporation.
How problematic is project suspension in construction today?
Miller: We see this issue in small retail building. We have also seen mixed-use facility condominium projects incurring some of these same problems. Project suspension is more significant in certain geographic areas; however, there are actually some regions of the country where one would be hard-pressed to tell that there is a slowdown at all.
Is this problem mostly on the private side, or are public entities, municipalities and states starting to suspend and cancel projects as well?
Miller: We saw public project suspensions in some areas where tax revenues have been decimated. This was particularly noticeable when public entities did not use bonding to support their construction, but used sales tax and other general revenue funding mechanisms instead.
What are some of the immediate actions contractors should take when a project looks like it is going to be suspended, and what do they need to do in the longer term to protect themselves?
Murphy: Contractors must understand that project suspension has always been a potential problem, though it was not as common in the past. Typically, if contractors felt comfortable with an owner, they did their background research and agreed to build. Now banks are suddenly refusing to provide the owner with money, so the job stops. When this happens, the stage at which the job stops becomes a major concern. Has the contractor thought about the contractual language in the event that project suspension occurs? If the contract language lacks provisions for job suspension, it becomes difficult to resolve who is responsible for what, such as security, quality control and quality assurance. There is a whole array of potential problems for which the contractor, the owner and the bank could be responsible.
Miller: If the contractor pulls out a contract today and finds that it lacks suspension or contract-stop language, it is time to sit down with the owner and discuss this issue. Problems arise not because contractors do not know or understand what to do, but because they encounter issues due to a lack of focus on the potential problem before it happens. Usually, after an owner goes bankrupt, the opportunity for dialogue to work out these issues is minimal. For instance, who has the responsibility for environmental storm drain runoff? This is an example of the type of problems for which general contractors have to foot the bill, even though it was never within the scope of their project. The contractor is unlikely to be paid for solving this problem, but may need to cover the expense to protect the public. Contractors make these types of investments to protect their good name on the street.
Murphy: Another important step for contractors is to retain documents and records of what they have done up to the point of project suspension. Contractors must have a high-quality documentation program. Information must be preserved up to the point to that the project was built, including video and pictures of what the site looked like when construction stopped. A copy of the contract, contract amendments, change orders and all other documentation leading up to the project suspension are also necessary.
All of this information must be retained in a jobsite file at the contractor’s home office. Then if there are any questions two, four, or 10 years from now, the information can be recovered and used to explain what the jobsite was like when the project stopped.
What’s the best way to resume a suspended project, whether it was something the contractor started or is coming in to finish? What are some of the challenges contractors may have with these sorts of projects?
Murphy: Let’s say a contractor put the HVAC system into a building but later had to shut it down and board up the windows. Then he comes back to finish the project two or three years later. Does the contractor have a warranty on that equipment? Or what if a contractor erected a structural steel building that was suspended. When he returns two or three years later, does the contractor need to replace the steel? Does the entire structure need to be sandblasted so the fireproofing will adhere to the steel? There is a wide range of concerns that must be considered when a project isn’t taken to completion and turned over to its owner.
Miller: From a strategy perspective, decommissioning a project that is suspended is a challenge. The previous contractor should have archived all of the pictures and details regarding the point at which construction was suspended. New contractors that come in should have a similar strategy and need to ensure they take good pictures before assuming responsibility for the job, documenting the existing conditions thoroughly.
Contractors must develop a strategy that protects their interests, thereby helping to avoid making replacements beyond the scope of their new contract when the project starts up again. This is probably the most unfortunate part of the whole process because it is a frictional cost added to the construction project. Significant protection activity occurs at the project stop, and the new contractor will need to take the same measures to safeguard his or her interests. All of these actions are necessary to make sure people have a clear view of the contractor’s scope and responsibilities incurred, from a warranty perspective and builder’s risk exposure.
What are clients that are forward-thinking and best in class doing to mitigate their risk from project suspensions?
Miller: Most of them have a perspective of prevention. In terms of risk-management strategies, the contractors that are prevention-focused are going to have a better cash return than those with reactive strategies. Most that have experienced project suspension in the past recognize that an ounce of prevention is worth a pound of cure. Some of Zurich’s contractors are actually sitting down to address the “what-ifs” to make sure they understand what they need to do. This practice allows contractors to maintain good relationships with the owners so when things improve, they will be better-positioned to get the work when it comes back and have a chance to help make these project suspensions and restarts a win-win for everybody involved.
Would you typically recommend your clients take a preventive stance up-front, making sure the language is in the contract and these concerns are addressed proactively?
Miller: I recommend contractors review tactical plans within their different functional areas. For example, the equipment management department must determine how to get equipment off-site? Consider a situation where a project goes bankrupt and the contractor has cranes sitting and cannot get access to decommission them because the financing fell through, or because there is a completely new owner who is unwilling to give control and access to the site. How do you get your people in and out of the project to get their personal tools off the job? I think contractors should proactively create a plan for each of their key functional areas, such as material supply, quality control, equipment and labor.
Murphy: It also is important for contractors to look at the types of insurance coverage they need. For example, who is responsible for maintaining site security when the project ends?
Describe some of the “horror” stories—the consequences contractors might face in this process. What happens to a contractor if there is not resolution around who will address environmental issues or site security?
Murphy: We can use site security as a potential horror story. Site security, if abandoned, could become a real issue for the owner, the contractor and the insurance company. Six months from now, who is going to be responsible for keeping kids out of this worksite? This doesn’t happen to every contractor, but it is important to ask the right questions.
Miller: It is a very viable concern, and I cannot think of a project suspension or termination that is not a tragedy. Everybody loses when these things happen. There are issues with losing good jobs in the community. Suspensions can also have devastating effects on the contractor because there are often items set up for payment that never happen. One particular job had just received more than a million dollars’ worth of materials on-site and they ended up arguing over that money for another year and a half before it was moved to the right place. It cost the contractor dearly, including his relationship with the supplier and his ability to do work for the owner in the future.
Murphy: It can be very damaging not only to the general contractor, but also to the first-, second- and third-tier subs. If there is no money, how are they going to be taken care of? How will they be paid for the work they have done up to that point? If the money dries up, suddenly it becomes an issue of an electrician who can no longer feed his family. There are many repercussions with the issue of project suspension.
From Zurich’s perspective, what are the trade contractors’ concerns since most of them work on a “pay-if-paid” basis, and how might they be different from the general contractor’s concerns?
Miller: There may be some contractual provisions that will help the trade contractors. Many trade contractors can’t finance their payroll if they miss payments for two or three months. Some of them are working on a shoestring budget; so if the money is dragged out for six months to a year trying to settle the final payment, those companies could be severely damaged. We are seeing evidence of this all over the country right now, where trade contractors’ business is being drastically slashed. And there is a minimal credit line available to help these companies continue to operate. Many of them end up in bankruptcy.
Apart from these financial concerns, what are other concerns specific to trade contractors in respect to project suspension or project cancellation?
Miller: I think the biggest concern is warranty. For example, an HVAC contractor may have a sense of what the scope will be, the materials required and the warranties they are going to support. If the materials and equipment are never completely put together, commissioned and started, the issue of warranty support becomes very gray. That is probably the biggest exposure with electrical equipment, HVAC and some of the boiler machinery for commercial buildings. It becomes very difficult to determine who is holding the bag in terms of maintaining ongoing warranties.
Murphy: There are a couple of potential issues here. First, what kind of warranty support is the product manufacturer going to provide if the contractor is unable to do a full installation, startup and commissioning? Second, what if one company buys the equipment, and it ends up being stored in a building or container and another contractor installs it two years later?
Miller: No structures are strongest until full completion, when all the components are in place. In terms of insurance exposure, a point of contention may be determining when the builder’s risk coverage stops and property coverage begins. This usually involves a date with transitions, punch lists and substantial completion. With a suspended or terminated project, how do owners get coverage for a project that may be partially completed? They will need to have a relationship with a carrier to manage and cover that property on an ongoing basis. Providing coverage for a building that is not completed and may not be able to handle a windstorm or other exposures could be a complicated issue for the insurance carrier as well.
A theme with every horror story I’ve heard from a contractor is the belief that he didn’t think it would happen to him, or that there was no way that this particular owner could be exposed to it. I recently had a conversation with an owner who never thought he would be in bankruptcy. He never saw it coming, and his entire team is devastated by the whole event. Assuming a project suspension could not happen leaves contractors or owners vulnerable. I would encourage people to give this issue a thorough review, discuss it with their department heads and team leaders and identify what they have done to be prepared for such an event.
Ultimately, project suspension is nearly always a traumatic situation, but with the proper planning it need not necessarily be a fatal one.