Project Selection: Anatomy of a Train Wreck

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What happens when things go wrong on a job? When they do, what can we learn from it so that we don’t make the same mistakes again? Stephen has a case study this week that contains multiple important lessons that all contractors should hear.

Topics we cover in this episode include:

  • A case study in construction failure
  • Breaking down the facts
  • Make sure insurance covers anything your project touches – including existing buildings
  • Have conversations with the architect before the bid
  • If you’re redoing work for a bond claim, be prepared to tear everything up 

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

TRANSCRIPT

[00:00:05] Wade Carpenter: What happens when things go wrong on a job? When they do, what can we learn from it so that we don’t make the same mistakes again?

This is the Contractor Success Forum. I’m Wade Carpenter with Carpenter & Company CPAs. With me as always, Stephen Brown with McDaniel Whitley, Bonding and Insurance. Stephen, what are we talking about?

[00:00:23] Stephen Brown: We’re talking about a case study that our listeners can just kick back and listen to. Don’t know the contractors involved here. Hope it wasn’t you that was involved, but it’s a story of a perfect storm of so many things.

I just thought I’d read it to you and then we can talk about it a little bit because in almost every paragraph of what I’m getting ready to read to you, there’s at least a half a dozen observations that I have of things that went wrong.

And this case study is not so rare that it’s a strange one to bring up, Wade. It happens more than once. I have lots of horror stories from other situations, so it’s just how you learn.

[00:01:05] Wade Carpenter: Absolutely. I know back in tax class and audit class, that was one of the things I loved to hear is when things went wrong. And in the bonding world, when things go wrong in construction, they go really wrong sometimes. And I was looking at this case study and seems like several things were done wrong here, but.

[00:01:23] Stephen Brown: That’s right. And originally, I was thinking, okay, this should go into a subcategory of project selection. But it also has issues of insurance, horrible communication, everything between an owner and an architect and three different contractors that could go wrong was going wrong. And how easily it could have been averted.

So anyway, I’m just going to read it to our listeners and then we’ll talk about it if that’s okay with you.

[00:01:52] Wade Carpenter: Yeah just tell us the story.

A case study in construction failure

[00:01:53] Stephen Brown: Alright. In 2004 through 2006, one of the more remarkable examples of construction failure was directly related to the omission of a proper builder’s risk policy. The situation involved an 8 million addition and rehabilitation of an existing middle school.

The awarding authority is one of the most difficult to deal with in the entire state, and the architect did not create the best set of plans. So, with that as a backdrop, I think we can all benefit from learning what transpired.

The project was bid in early March of 2004. All of the bids were in line, and the bonds were provided by Class A surety. For purpose of this illustration, we will not utilize the names of the three contractors involved, two of which are no longer in business, as a direct result of what occurred. Contractor One had been in business for over 15 years and focused primarily on public construction. They were awarded the project and proceeded to begin renovations to the existing building and prepare the site work for the new addition.

Approximately four months into the project, Contractor One commenced the erection of steel at a critical point where the new building joined the existing building. While installing the roof joist, a welder apparently generated slag, which caused a fire to start in the interior wall of the existing building, even though there was a fire watch in place.

Despite the best efforts of the local fire department, the building was significantly damaged. It’s important to note that this project had a very difficult construction schedule, and that the school committee of the local town was actively involved in decisions related to the completion of the facility.

Initially, Contractor One notified his insurance carrier, who immediately began an investigation of the claim. As it turned out, the builder’s risk policy, which was purchased by the contractor, specifically excluded renovations to existing buildings, and only provided coverage for new construction.

Counsel for the Contractor One requested if the town had made arrangements to schedule the existing building on their policy. As it turns out, their carrier also discovered that the existing building was not covered.

The town immediately notified Contractor One and its surety that they demanded the project continue due to the tight schedule. They also expected Contractor One to immediately proceed with the repairs to the damaged building. After advice from the counsel, they decided to comply with the request under protest while attempting to negotiate reimbursement. for their cost.

After struggling for two and a half months to bring the project under control, Contractor One notified the surety and the awarding authority that they were unable to complete this project along with several others and they discontinued their operations.

Since the project was well along, the surety elected to negotiate with one of their preferred clients in order to complete the school as expeditiously as possible. Enter Contractor Number Two. This company had been in business for nearly 100 years and enjoyed an impeccable reputation.

Although Contractor Two had vast experience in all types of construction, they were relatively a new entrant to the public school market. And since time was of the essence, they signed a lump sum contract with the surety and ratified almost all of the subcontractors on the project.

Contractor Two apparently did not realize that the completion contract which they signed did have a pay when paid clause. And at this point, the project had been floundering for several weeks, and the owner was not happy.

Contractor Two put its best resources on the project in an attempt to make up the schedule. The most critical aspect of this project, at this point in time, was repairing what was left of the fire damage and completing the rehabilitation of the existing building.

This is when they encountered major problem number two: the electrical sub on the project certified that they had completed 75 percent of the contract for the entire project.

And as contractor two began the demo and rehab on the existing building, they discovered, among other things, that the electrical contract was only 25 percent complete. Contractor Two approached the surety and the town in an attempt to negotiate change orders for the additional work and were flatly denied.

Requisitions that were pending, in excess of a million dollars, would not be paid until they completed the repair work. The surety informed Contractor Two that they had signed a completion contract with the Pay When Paid Clause. Therefore, they would be forced to complete the school with their own resources and negotiate for payment at a later date.

Shortly after receiving this decision, Contractor Two advised the surety that they would be unable to continue their operation without payment and were forced to cease operations. The town was infuriated by this development and everyone started to speak through lawyers. Needless to say, this project was generating a tremendous amount of publicity, including negative publicity for the surety industry.

Enter contract number three. The surety decided that it was in their best interest to negotiate with a completion contractor who they did not represent, but was able to provide a bond for the roughly 2 million worth of work yet to be completed. A deal was worked out in four days.

Contractor Three refused to sign the completion contract rendered by the surety. After eliminating all of the owner’s conditions, including the pay when paid clause, they stepped in and completed the project within 10 weeks.

The postmortem on this little project involves substantial litigation and the demise of two very capable contractors. An intelligent decision was made by someone in the mix as the entire matter involving the dispute between the owner, surety, and both contractors was defaulted, and it was settled before it was fully adjudicated.

The case illustrates what can happen if the insurance requirements, particularly when dealing with the renovation and addition, To an existing building or not properly addressed. Not only do we have to be cognizant of who’s responsible for providing builder’s risk, we must be clear on the exposure and make certain that the coverage complies.

This is indeed a challenge because there are so many manuscript forms being utilized by carriers whose coverage can be substantially different depending on the carrier. So.

[00:08:14] Wade Carpenter: All I can say is, wow. There’s a lot of missteps in that. And can we maybe break that down one by one?

Breaking down the facts

[00:08:21] Stephen Brown: Yeah, there’s just so many moving parts here. So, first of all, there’s facts that we know, what I just read to you, and then facts that we don’t know. So, we’ll discuss all of those. So, it’s an $8 million overall project, and they’re putting an addition to an existing school.

And problem is, that particular school, or which Contractor One had not done work with them before, was a particular pain in the ass. So when I say that, maybe they weren’t, but they were actively involved in something that they really should have stayed out of.

Whenever you have a committee building a construction project, everyone has their own agenda. Everyone has their own perceptions. And I can just tell you from work on our church, that it can turn into a mess. So that’s number one. Number two is the architect put out a poor set of plans. So the architect should have had in the plans the exact terminology about the builder’s risk and who was included under this builder’s risk policy that was not issued properly.

Okay. So that’s just in the first paragraph. You ready for me to move on?

[00:09:28] Wade Carpenter: Absolutely. As far as the risk, it sounds like there’s a lot of missteps there too.

[00:09:33] Stephen Brown: Yeah. Well, it was an $8 million project taking two years. So that would be a $16 million project today, would be my guess. But anyway, it bid in early March, which was perfect timing to start the job, except for the steel frame, which was added on four and a half months later. How much renovation was being done to the existing building? I don’t know.

But that Contractor Number One, it says here, had a Class A surety. So what does that mean? It just means they were considered one of the better surety markets, better claims markets. I tend to disagree as we study this. But they handled everything textbook, like a surety claims department would handle things.

So contractor one had been in business for 15 years and they weren’t experts in doing schoolwork and renovations. Now remember that school work done in March, except for the timeframe, the school board is only interested in that school starting up.

[00:10:34] Wade Carpenter: Right.

Make sure insurance covers anything your project touches – including existing buildings

[00:10:35] Stephen Brown: So whatever you have to do to the existing building, get it knocked out this summer, close it off, make it secure.

So when that fire occured when the welder, and we don’t know if the welder was a sub or an employee of the general contractor, but they caused slag from the weld to fall down in the existing walls of a building and catch on fire, even though there was a adequate fire watch in place.

So, Wade, I’ve seen this many times that fires have started inside walls from welding situations. So, there’s another lesson. So, fire starts, catches the existing building on fire, and the builder’s risk that the contractor was required to have did not cover the existing building. So, what could have been done about that?

[00:11:22] Wade Carpenter: The average contractor may not know those kind of things, so I think they would be relying on their agent, would they not?

[00:11:27] Stephen Brown: Yeah, and then their agent may not have read the contract before they issued the bond to check the insurance requirements.

Certainly, if I saw you were working on an existing building and needed a builder’s risk policy, I would know that there’s an installation floater risk involved. So installation floater is something you add to a builder’s risk policy that covers the existing building in case something happens during construction.

There’s a lot of questions in underwriting to be done. And if the owner has existing coverage on the building, well, you say, technically, I don’t need that, but you do. So my advice to every contractor is to make sure you are insuring anything your project touches, in this case, an existing building. If it touches the building, you make sure it’s covered somewhere, because it’s going to be your fault as far as the owner’s concerned, if anything happened. Well, you’re the contractor, you caused the fire. They don’t care whether you had insurance or not.

And they had an extremely tight schedule in place. Probably high liquidated damages too, which is maybe why the contractors pulled out so quickly.

Have conversations with the architect before the bid

[00:12:32] Stephen Brown: The next thing we talked about beside construction project being run by a committee and being difficult to owners, is that the the architect didn’t put out a very good Set of plans.

So as the contractor, you have some changes to a renovation 8 million project. There’s going to be changes. There’s going to be things that were unclear that have to be negotiated, and this has to go back to committee for decision and who’s going to lose face. The contractor is going to say, I forgot to put it in there.

Everybody’s going to generally blame the contractor as a general rule. So you want to really study that contract and know that architect or engineer for the type of work that you’re doing, especially if it’s new. So the more conversations you can have pre bid to clarify these things, the better.

And I can tell you, the architect’s really going to appreciate it because you’ll have brought things up before the bid that they need to know. And you may not even get that project, but I can tell you this, that architect engineering firm’s going to want to want you to be on their next project because you’re helping cover their butts.

That make sense?

[00:13:39] Wade Carpenter: Absolutely,

There’s a lot to talk about on Contractor 1, but now if we’re talking about Contractor Number 2, it sounds like they really didn’t do their homework on this one.

Is that the way you take it?

If you’re redoing work for a bond claim, be prepared to tear everything up

[00:13:49] Stephen Brown: The contractor number two was a favorite account of the surety. Now remember, when there’s a bond claim and you redo work for a bond claim, you got to be prepared to tear everything up. And even if if you’re taking over a job that’s 75 percent complete, if the language from the surety requires them to pass all of the buck and the warranty and the workmanship and everything to you.

and a paid as paid contract when they get paid by the owner you’re taking a huge amount of risk. And of course, why wouldn’t a surety want you to sign a contract like that? They just want to get the job finished quickly and move on. But this is a renovation project with a lot of moving parts to it. A whole lot of communications missing as well.

But they got one of their favorite contractors in there to do the work for them. And all that does is purportedly build up goodwill between the surety and one of their favorite contractors. Now bear in mind that they’re going to require a bond, even if it’s their favorite contractor.

[00:14:52] Wade Carpenter: Right.

[00:14:53] Stephen Brown: That’s like surety claims 101, anybody you hire to do any work is going to be bonded. So anyway, Contractor 2 had been in business for a hundred years. So I don’t know who was running that company or why they signed that contract. Maybe they were so excited that the charity just threw it in their laps and said, just, Give us a cost plus job to do this and sign this lump sum contract.

Well, they signed it without reading it.

[00:15:20] Wade Carpenter: Right.

[00:15:20] Stephen Brown: So asking if you’re going to get paid is the most fundamental thing in the world to a contractor, right?

[00:15:26] Wade Carpenter: Absolutely.

[00:15:27] Stephen Brown: So I guess they just assumed the surety would pay them. Not if the contract says that. So despite the fact that, that contractor number two’s agent and underwriter were apoplectic that their customer signed this contract, they should have been involved.

 The agent, I think, should have known to explain to them, read what you’re signing. If you’re going to take over another job that’s gone under, you’ve got to know exactly what you’re doing. And you also can’t warranty work that you haven’t done, right?

[00:15:58] Wade Carpenter: Right.

[00:15:59] Stephen Brown: And you have no idea how the owner’s gonna pay, and the owner’s pissed. So the owner is pissed, and everybody’s to blame.

Moving on down, contractor number 2 didn’t realize that the completion contract had a paid is paid clause. We talked about that. And then it goes on to mention that they discovered that the sub that had apparently billed out and been paid 75 percent of the work and only done 25 percent.

Okay, how does that matter? Well, they hadn’t gotten started on the new addition yet, so it was Contractor Number One’s fault that they paid that electrical sub for work that wasn’t done. Also, once the building caught on fire, who could prove what work the electrical sub had done or not?

So I don’t know why they put that in there or not, but I thought that was interesting. And then the next thing is the subcontractor or general contractor, number one that was doing the welding that caused the fire.

Even if the building had not been covered by the Builder’s Risk Policy, what about liability coverage? Does the subcontractor have adequate liability, coverage? That would have paid for the resulting damage.

[00:17:09] Wade Carpenter: Right.

[00:17:09] Stephen Brown: Had the general contractor turned in a claim for general liability, some of that coverage would be paid by their policy. And so I don’t know why that didn’t, didn’t come into play.

So anyway, contractor number two goes back to the surety and the city and says, Hey, we found out that we’ve got 50 percent more electrical work that was claimed to be done that isn’t done. And the surety said uh, you signed a lump sum contract to get this knocked out, that’s your problem. And so did the city. Okay. I’m not surprised.

[00:17:42] Wade Carpenter: You’d think you would have a little recourse against the electrical sub, but.

[00:17:47] Stephen Brown: Yeah, eventually. No telling how many lawsuits were kicked out by this. I imagine everything from the liability carrier to the subcontractor’s insurance to, I’m sure they even tried to file a claim on their insurance agent’s errors and omissions policy. But or file a claim on the architect’s E& O policy for not putting together a good set of plans.

So there’s a lot of people at fault here, Wade.

[00:18:12] Wade Carpenter: Well, contractor number three was smart to look at the contract first before signing it, and know what they were signing and it sounds like they held their ground on, we’re not going to do a pay when paid, and those kind of things.

[00:18:24] Stephen Brown: Yeah, that’s right. And so I’m just curious of how much the 8 million originally that the city had to spend on this project, how much was given out to contractor number one and number two and number three. We know number three was $2 million. So apparently they had accepted a good chunk of contractor number two’s work, but they weren’t paying him.

[00:18:49] Wade Carpenter: Right.

[00:18:49] Stephen Brown: They were pissed off at everybody. And the surety wasn’t communicating with the contractor properly. They were just acting like a bunch of attorneys.

[00:18:58] Wade Carpenter: Right.

[00:18:58] Stephen Brown: And holding their feet to the fire because that’s what they do.

And there wasn’t regular communication with the city school board, letting them know of the problems, and trying to talk them through. Even though they may have put their foot down early and said, I don’t know, we signed a contract, we’re not talking to you, just get it done.

And then they started disrespecting the surety industry, which immediately got somebody moving somewhere, got the attention of a higher up at the surety company that was pushing things forward. So anyway, everybody’s ticked off and we’re near the end of this case study, but everybody’s ticked off and they’re only talking to their lawyers.

[00:19:37] Wade Carpenter: Yeah, it sounds like in a situation like this, there’s no winners. I don’t care who actually eventually prevailed on any of their lawsuits, but nobody’s a winner on this case. And–

[00:19:48] Stephen Brown: Right.

[00:19:49] Wade Carpenter: My hope is that people maybe learn something from that. Maybe the, yeah, lawyer’s won, maybe.

[00:19:55] Stephen Brown: Well, lawyers get their fees out of dysfunction. They’re going to win. Are you going to get mad at them for doing their job? No. That old expression, the buck stops here. I can tell you, there’s a lot of good attorneys that do everything they can to communicate, minimize risk. And then there’s the other type.

So. Anyway, tons of litigation, two contractors going under. The third one made out fine, got in and out, got their profit. Not reading the contract, not understanding who they’re dealing with, owner and architect, not understanding the intricacies of school work, and I say specifically school work, but it’s any building addition that’s attached to an existing operation.

There’s huge risk involved there. There’s risk to protect the public going in and out of the building. There’s risks for the people in the building. There’s fire risk to the existing building, damage to the existing building. So over the years, I’ve added every claim to an existing building you can have.

I’ve had every contract you can imagine cause a problem to someone. So again that’s all I wanted our listeners to know. We’d love to hear your comments. What do you think?

[00:21:05] Wade Carpenter: Well, again, I think there’s a lot of things that can be learned from looking at the mistakes of the past, and I’m hoping somebody listening to this maybe got something from it. If nothing else, being careful. So,

[00:21:18] Stephen Brown: Let us know what you think.

[00:21:19] Wade Carpenter: Have you got any thoughts or feedback on what we discussed today?

We’re always happy to answer some questions or hear your thoughts on the topics you’d like to hear us discuss in the future. If you would, drop them in on our YouTube page or on the comments on the show notes. We would love to hear from you.

And wanted to thank you all for listening to the Contractor Success Forum. Check out the show notes at Contractorsuccessforum. com or to the Carpenter CPA’s YouTube channel for more information. We would appreciate it if you consider subscribing, like the podcast, subscribe, and follow us every week as we post a new episode. And we will look forward to seeing you on the next show.

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