A defaulting subcontractor is bad news for everyone.
The project must be halted, money is lost on all fronts, including bonding companies and project owners, and others are less likely to work with the subcontractor in the future.
Managing subcontractor risk appropriately is key to preventing this bad news: General contractors do not need to take the full risk of a subcontractor default on themselves.
Proper default clauses, responses, and general risk management can help prevent defaults and mitigate any damage done.
Watch Out for Warning Signs
During the pre-qualification process, attempt to weed out all high-risk contractors. Examine the track record of potential subcontractors, their financial assets, and their project backlogs, among other signs. Check the references they provide, and note their safety records if this is a concern. You may also want to contact your surety company to see if they have any past experience in dealing with a particular subcontractor. These pre-qualification steps will help remove many of the high-risk options.
At times, you may have to make due with a contractor that has a higher level of risk than you would prefer. Here it is time for contract alterations: Ideally, you will have several different contract options that you can use based on risk. For example, if you are concerned about material quality, you can use a labor-only contract where you retain control over material selection. Other contracts can have similar limitations for greater control.
Surety bonds and SDI policies can provide some protection against default, but they will not help you reclaim lost time. If possible, use additional guarantees to help encourage subcontractors, including letters of credit and personal guarantees from the owners of the subcontractor.
Provide room in your contract for periodic audits if you believe that a subcontractor is high-risk Audits can catch problems before they spiral out of control and lead to defaults. You should also consider additional quality assurance, financial checks, an approval process for material purchases and additional hiring. If subcontractors show considerably variance in what financial records they submit and their contractual obligations, these need to be addressed immediately.
Waste No Time When it Comes to Claims
If you do have to make a claim because of a related discount, act immediately. Have all necessary data ready to go, particularly the direct costs the project still requires and the indirect costs incurred by the default. All points must be supported by documents and subcontract reconciliations.
Remember, a healthy or active industry is no guarantee of responsible, high-quality subcontractors, especially with large workloads. You must take time to properly vet subcontractors and prepare your company or project accordingly. Time spent in quality control will save much time lost through defaults.