Banking and liability insurance are two issues that are important to subcontractors. In light of the recent economic changes, I felt now was a good time to stick a thermometer into both industries to get a current reading.
My first interview is with Mr. James L. Davis, CEO of Fife Commercial Bank, located in Washington State. Mr. Davis has been in banking for more than 30 years and has banked many subcontractors.
Banking subcontractorsW&C: How does the banking industry perceive subcontractors?
J.D. I am not sure how the banking industry overall perceives subcontractors. The Regulators of the Banking Industry for some time now have mandated that banks emphasize credit quality in their lending functions. This emphasis on credit quality is not specific to subcontractors. I have heard of an instance when one major bank has decided to eliminate all credits extended to any business in the construction industry. Personally, I like subcontractors. However I look at every subcontractor individually.
W&C: How do you feel about today's contracts?
J.D.: Contracts concern me! Contracts are a liability until they are complete. I suggest that subcontractors review their contracts closely-or better yet-establish their own contract form to enter into an agreement. The most critical area of a contract is the scope of work. It must be clear and concise. Both parties must understand the extent of the bargain! Contract language has become a concern due to the complexity of the language, as well as the successful transfer of liability to lower-tier subcontractors.
W&C: Based on your experience, what generally causes subcontractors to fail?
J.D.: Many subs have the skill to do the work, however they lack the knowledge to be managers. Subcontractors must acknowledge their weaknesses and get help.
W&C: Are there common elements you see in being a successful subcontractor?
J.D.: I believe strong management, as well as management's hands-on involvement in the entire process of subcontracting, is key. Subs must know what their costs are as well as their current financial condition. Subcontracting is more management intensive than other businesses, in my opinion.
W&C: Do you understand that subcontractor payment is conditioned upon the owner paying the general contractor?
J.D.: If I were a subcontractor, I would not agree to a "paid-if-paid" clause. If I were a subcontractor, and if I were to agree to a paid-if-paid clause, I would require complete financial information on the owner, as well as the general contractor. I would want to know specifically how the financing was being arranged on the project. Most contracts have this language and in my opinion, I would strongly suggest subcontractors protest such language.
W&C: A paid-if-paid clause seems to be a hot button for you. I see your face turning a bit red.
J.D.: It is a hot button because it is not done in other industries and I don't believe it is fair! The clause places most of the risk on the subcontractor who has expended money on material and labor, which may or not be paid.
W&C: What is your opinion on subcontractors filing liens for non-payment?
J.D.: We expect our customers to file liens. If they have not been paid for the work they have performed they should without a doubt file a lien!
W&C: Does the banking industry perceive subcontractors as a loose-knit group?
J.D.: There are many good organizations subcontractors can join. However, I believe these organizations could do a better job of strengthening the position of the subcontractor. Contract negotiations are one area in which organizations have fallen very short. Subcontractors need and deserve better protection from current contract language including the paid-if-paid clause.
W&C: In the last several years, subcontractors have been involved in some serious lawsuits having to do with water intrusion. Do you see these lawsuits affecting the willingness of banks to loan money to subcontractors?
J.D.: I have heard of lawsuits involving water intrusion but I cannot speak on this specific issue. We may at some point see contractor-banking "specialists" in lieu of loan officers making loans to subcontractors. Subcontracting has become more complicated and it may take a specially trained loan officer to do this kind of work.
W&C: What can a community bank offer that large banks may not?
J.D.: We make our decisions at a local level! If you need a loan you can see me and I can say "yes" or "no" right away. The personal service and attention a community bank can offer should exceed anyone's expectations.
W&C: What should subcontractors be doing during this economic slow down?
J.D.: Construction has cycles and we are seeing a downturn. I would suggest that contractors limit or eliminate long-term debt. As well, I think it is a good idea to limit fixed assets and overhead expense. What I'm trying to say is that subcontractors must be flexible. They must be able to shrink or grow in a very short period of time. The window of opportunity in construction opens and closes quickly and a subcontractor must be in a position to react to these variations. If there are any contractors who would like to talk to me visit www.fifebank.com.
Liability insuranceMy second interview is with Mr. Jim Adair, district manager for Mutual of Enumclaw Insurance. Mutual of Enumclaw was established in 1896 and currently provides many types of insurance coverage, including subcontractor liability insurance.
W&C: Is your company experiencing construction-related claims?
J.D.: We have an approximate annual income from contractor premiums in the amount of $20 million. Currently we are involved in $17 million worth of contractor-related claims.
W&C: What are the major claim issues?
J.D.: Water intrusion in multi-family residences.
W&C: Once you settle these claims, you may find you're not responsible for the entire $17 million?
J.D.: I would hope not! The problem is that we have to prepare for the worst and the worst could be the full amount.
W&C: Are other insurance companies seeing the same type of claims?
J.D.: Yes, and many of them are choosing to get out of the contractor market.
W&C: What does that mean for subcontractors?
J.D.: It means that it will become more difficult for contractors to get coverage. It also means that rates are going to skyrocket! In addition, you will see insurance companies begin to make exclusions to policies that will directly affect the subcontractors coverage.
W&C: When you say "skyrocket" what does than mean in dollars and cents?
J.D.: We have heard as high as a 300-percent increase in the industry. It may not be that much but we do know rates are going to increase greatly and coverage reduced.
W&C: How can you justify an increase like that?
J.D.: It could be less or it could be more. Insurance costs are determined by history. Once we determine how much we paid out, we are able to determine how much we must charge the customer. Claims and the cost of defending the claims in construction have become very costly.
W&C: Does the cost of defending a contractor in a claim such as the attorney fees reduce the amount of coverage the contractor has over all?
J.D.: Yes! The money we spend defending a contractor from a claim is subtracted from the contractor's total. If the contractor has $1 million in coverage and the cost to defend is $300,000, then the contractor is left with $700,000 to correct the defect or issue. If the cost to fix the problem exceeds the amount left to cover the actual work the contractor would be responsible for the excess.
W&C: Are insurance companies concerned about contract language for subcontractors?
J.D.: Yes, we are concerned! However, we only provide insurance in the amounts required by the contract. The contract insurance requirements are specific and that is what we look at. As far as all the other contract language, we leave that to the subcontractor to work out.
W&C: What do you mean?
J.D.: I mean, we provide insurance in the limits requested. We don't normally look at all the obligations or payment issues the subcontractor agrees too. We look at just the insurance requirements. We have enough liability without getting involved with the details of the agreement.
W&C: What does "Primary Additionally Insured" mean?
J.D.: It means that if you name a general as primary additionally insured, your insurance will pay out first including the defense costs. The general's insurance would then be excess in the event you did not have high enough limits. It means the general gets to sit back and let your insurance company take care of it until your limits run out.
W&C: Let's go back to your current claim condition. You say you have $17 million in claims. From the total of subcontractors you provide coverage for, how many subcontractors are involved in these claims?
J.D.: Only about 10 percent.
W&C: You're saying that rates are going to go up like a rocket for all subcontractors when only 10 percent of them are having claims?
J.D.: Yes! We look at the cost of the entire group in that construction category.
W&C: Why don't you have an elite group of subs that don't have claims so you can give them the best price and coverage?
J.D.: We thought we had a great group but the claims still appeared!
W&C: You say many of the claims are for multi-family projects. Why do these claims have to be settled in court in lieu of the parties working it out?
J.D.: There are those who approach homeowner associations offering to "monitor" their building for a small fee. If a defect is found during that process, the monitoring service then offers to litigate.
W&C: You mean it's become a business to find defects in multi-family construction?
J.D.: Yes. I have a customer who just finished building a condo complex and on the first day of the open house found a "door knob hanger" saying they will monitor the building for construction defects for $2,500.
W&C: So, the days of solving these kinds of problems between individuals are gone?
J.D.: Yes. There are professionals who are stepping in to offer their assistance in this whole area of defects!
W&C: Subcontracting has then become a much higher risk business due to this practice of "monitoring for hire"?
J.D.: Yes. It has become a higher liability business. You are in a business, which not only carries high liability for construction and manufacturer defect claims, you are also in a business that carries a tremendous amount of liability in the form of contract language for which you don't have coverage.
W&C: What can be done to limit claims thereby reducing insurance costs?
J.D.: There are many things we can do, such as getting out of certain markets or not providing additional insured endorsements. Subcontractors must make sure they perform their work perfectly, as well as making sure the trade before them performed their work perfectly. Contractors should not perform any design work and not offer to get involved in design. Subcontractors must find better methods of documenting potential defect problems on job sites. Don't sign contracts without getting professional advice. Be careful whom you work for and reconsider the type of projects you will work on.
W&C: Subcontractors must consider the higher risks associated with their work?
J.D.: Absolutely! If you are involved in a claim, you will be glad you took this approach! These claims are getting so big that we are finding many contractors do not have high enough limits to cover the final cost.
W&C: What happens when the claim exceeds our coverage?
J.D.: The subcontractor pays the excess once limits are exhausted!
W&C: You're saying that nationwide liability insurance is going to substantially increase this next year?
J.D.: In my opinion, yes! Most insurance companies in the business of providing liability insurance to subcontractors and general contractors have experienced greatly increased costs due to these claims. As well, there are many other claims in the pipeline having to do with mold and mildew, which we are concerned about!
The banking industry is changing and becoming, for the most part, aware and cautious. Bankers understand the difficulties associated with subcontracting. I can also see that subcontractor/banking relationships may become a bit more complicated in the future.
Insurance companies are also indicating the cost of insurance is going to greatly increase with the possibility that coverage will decrease.
I hope this information helps all of us make informed decisions on the subject of banking and insurance as we prepare for our annual renewals! We have the technology to orchestrate such an organization! Ah, yes, but do we have the solidarity? The lack of solidarity (especially during an economic slow down) is something generals have been using against contractors since Noah built the arc.
Remember how everyone came to Noah's house to tease him about his building project? Day in and day out people would say, "Are you nuts Noah, why in the world are you building a big ship in the middle of the desert?"
He replied, "There is going to be this big flood, my friend," but the people persisted in teasing him. Then it started raining!
Remember: Teamwork begins with a fair contract! W&C