A subcontractor default can disrupt even a well-planned construction project. When a subcontractor can’t meet its contractual obligations—whether because of financial difficulties, staffing or resource shortages, or performance issues—the general contractor or project owner may be left dealing with schedule delays, additional costs, quality concerns and the challenge of getting the work back on track.
The best time to address that risk is before the subcontract is awarded.
A thoughtful prequalification process, ongoing monitoring and well-structured contracts can help project owners and general contractors identify potential problems early and make informed decisions throughout the life of a project.
Prequalification: Look Beyond the Bid
Price is an important part of any construction project, but it shouldn’t be the only consideration when selecting a subcontractor.
A strong prequalification process can help determine whether a subcontractor has the experience, financial strength and operational capacity needed for the specific project.
Consider four areas when evaluating potential subcontractors:
- Character: Look at the company’s reputation and track record. References, certifications, safety records, company history and relevant litigation history can provide insight into how the subcontractor operates and performs.
- Capacity: Consider the subcontractor’s current workload, staffing and access to necessary resources. A company that is stretched across too many projects, experiencing significant employee turnover or struggling with supply-chain management may have difficulty meeting the demands of another project.
- Capital: Financial strength matters. Cash flow problems can affect a subcontractor’s ability to pay employees, purchase materials and keep work moving. Financial information can provide valuable insight into whether a subcontractor has the resources to complete the project. An unusually low bid may also warrant additional questions about how the subcontractor plans to deliver the work at that price.
- Coverage: Verify that required insurance and bonding are active and adequate. This should be checked during the bidding process and again when work begins. An uninsured or inadequately insured subcontractor can create significant financial exposure for the project owner and GC.
Prequalification isn’t about finding a subcontractor with no risk. That’s not realistic.
It’s about gathering enough information to make a more informed decision before committing to the work.
Keep Monitoring After the Award
Prequalification shouldn’t necessarily end when the subcontract is signed.
For projects with a long gap between bidding and mobilization, it may make sense to refresh financial and operational information before work begins. On lengthy projects, continued monitoring can also help identify changes that weren’t apparent at the beginning.
Watch for potential warning signs such as missed milestones, inconsistent staffing, overbilling, requests for early payments or other changes in performance.
None of these automatically means a subcontractor is headed for default. But they may be reasons to ask questions and investigate before a relatively small issue becomes a project-wide problem.
Communication matters, too. Preconstruction, field operations and risk-management teams should have a process for sharing concerns about subcontractor performance. The earlier a potential problem is identified, the more options the project team may have to address it.
Use the Contract to Define Expectations
A well-structured subcontract can provide another layer of protection by clearly establishing responsibilities, performance expectations and remedies when those expectations aren’t met.
Depending on the project and the parties involved, contracts may include provisions addressing:
Flow-down requirements: These can make certain obligations and responsibilities under the prime contract applicable to the subcontractor and establish accountability for meeting them.
Bond and payment requirements: Appropriate lien waivers, bond requirements and payment certifications can help document payment obligations and provide additional safeguards throughout the project.
Termination provisions: A termination-for-default provision can establish what constitutes a failure to perform and what steps may be taken if a subcontractor doesn’t meet its obligations. A termination-for-convenience provision may provide additional flexibility to end a subcontract under specified circumstances.
The appropriate contract language will depend on the project, the parties and applicable law. Construction companies should work with qualified legal counsel when developing or reviewing subcontract agreements.
Insurance and Bonding Are Important—but They’re Not the First Line of Defense
Insurance and bonding can be valuable parts of a construction risk-management program, but they shouldn’t replace due diligence.
Knowing who you’re hiring, understanding the subcontractor’s capabilities and financial position, verifying insurance and bonding, and establishing clear contractual expectations can help reduce the likelihood and potential impact of a default.
If a problem does arise, having that information and documentation already in place can help the project team respond more effectively.
As the source material emphasizes, insurance and bonding are valuable backstops, but they are not substitutes for thorough prequalification and due diligence.
A Practical Approach to Subcontractor Default Risk
No contractor wants to deal with a subcontractor default in the middle of a project. But planning for the possibility isn’t pessimistic—it’s good project management.
Before your next project gets underway, ask:
- Do we have a consistent process for prequalifying subcontractors?
- Are we evaluating financial strength as well as experience and reputation?
- Do we understand each subcontractor’s current workload and capacity?
- Have we verified the required insurance and bonding?
- Do we have a process for monitoring performance after the subcontract is awarded?
- Are our contract provisions appropriate for the risks of this project?
- Do our field, preconstruction and risk-management teams communicate when potential warning signs appear?
A strong construction project isn’t one where nothing ever goes wrong. It’s one where the team has processes in place to identify problems early, make informed decisions and keep the project moving.
The Final Word
At Deeley Insurance Group, we look beyond the policy itself to understand the risks that can affect a project from the ground up. We’re here to help our construction clients evaluate their insurance and risk-management programs and prepare for the risks that come with doing business.
The best time to manage subcontractor default risk is before you need to.
Reach out to the Construction Insurance experts at Deeley today. Call or text 410.213.5600.
