By Andrew Mewing and Chris Hargreaves
Sometimes, the best contracts are the ones that you never sign. But how can you tell the difference between those and your next big break?
Fear not – we’ve got you covered.
Of course, there are no hard and fast rules, and the reality is that no contract is perfect. You’ve got to make money though, and sometimes you’ll know the risks and take the plunge anyway.
But a collection of otherwise small issues might be a sign that it’s time to walk away.
These tips apply to all links up and down the contracting chain in the construction industry:
- Developers engaging contractors;
- Contractors engaging subcontractors;
- Contractors assessing developer clients;
- Subcontractors assessing contractor clients;
- And so on.
What Does Your Gut Say?
Don’t underestimate that feeling in your bones.
You know when you go Christmas shopping for a close relative, and you usually find what you’ll buy them quickly.
After that, you spend the next few hours/days/weeks (depending how close they are) second guessing yourself, only to return to the place you started.
Sometimes your instincts are going to tell you that the people you’re dealing with aren’t on the level. Something’s wrong.
You might not know what’s wrong, but if you’re getting the heeby jeebies and you’re not normally prone to them, then it’s definitely worth poking around rather than just dismissing your concern.
Where’s the Competition?
If you’re the only horse in the race, you have to wonder why.
No doubt you have a good feel for who your closest competitors are. If they’re not tendering on this job, then it’s worthwhile poking around to find out what the deal is.
Unknown quantities? Too many disputes? Bad blood?
Some of these might be deal breakers and others you can live with, but don’t swallow the whole “we’ve only come to you” line unless you’ve got an existing and close relationship with the other party.
A Long History of Disputes
It’s not too hard to check out whether your proposed other party has a long history of disputes or not.
An odd dispute here and there might not be uncommon, but if you see a huge string of cases involving that company or its directors, and they’re not big enough to warrant such attention – then you’ve got a potential time bomb on your hands.
If they’re usually the plaintiff, then you might be concerned that they’re going to inevitably scapegoat you for all of the world’s problems, possibly terminate you, and have a big argument about defects and delays.
If they’re usually the defendant, then you might wonder whether they constantly reject payment claims on spurious grounds.
The same concern goes for adjudication. In Queensland, a quick search will reveal if the other party is a habitual user, abuser, or respondent under the Building and Construction Industry Payments Act. Again, the odd adjudicated dispute should not be cause for concern (the Act is there for a good reason), but if they are popping up every few months, perhaps this shows a combative streak that you want to avoid.
Beware of Lazarus
Unfortunately, insolvency is the ugly cousin of the construction industry. Roughly 20% of all insolvencies, year after year, come from the construction sector. It’s a high risk game.
Many of the players have tried and failed before. Not all failures are caused by bad intentions, bad behaviour, or incompetence. Bad things can happen to good people.
However, if the other party is coming out of their third or fourth resurrection, or its directors have chequered histories with failed contractors, it pays to do a bit more digging to satisfy yourself that history won’t repeat itself on this project.
At a minimum, you should do a quick QBCC licence search of the other party and its key personnel. Is there any smoke leading to fire?
Are They In Over their Head?
What’s the work history of the other party? Have they ever done a job this big before – and what happened with it?
If you get approached by a developer with only 4-packs under their belt to build a 128 lot multi-use complex, then that’s a big shift in what they’re used to.
Are they up to it? Who’s funding them? What’s their expertise to deal with the ebb and flow of such a significant build?
That’s not to say that people can’t expand their horizons but just remember that, if you’re a contractor, your success depends largely on the developer’s ability to pay your payment claims and the subcontractors’ ability to walk the talk.
Have They Bought the Job?
There’s a funny saying in the construction industry to the effect that “The successful tenderer immediately wonders what they left out”. Many a true word is spoken in jest.
If you are the developer engaging a contractor, or a contractor engaging subbies, be alive to the real risks of a drastically lower tendered price. It might seem like a bargain, but why is the price so low?
Was the low price tactical, in that they have bought the job and expect to recover through variation claims? Then expect a war of attrition and be armed with relentless contract management.
Was the low price simply the result of incompetence, in that the bidder simply does not know what is expected of them? That scenario is even worse: expect the same war of attrition coupled with a real risk that the bidder will not even survive the project.
Is the Contract Full of Sleeze?
Opportunistic drafting usually doesn’t take the form of obvious stuff.
More regularly, the problems are in the clauses that nobody quite understands properly, or where the full impact of the clauses haven’t been considered at a daily, commercial level. They stare at them, read their lawyer’s advice, and think “oh well – it’s probably not that important”.
If a developer has gone to the trouble of having a contract prepared and refuses to budge on things that your lawyer is telling you are a real problem (not just “it would be good if you could change this” but “this makes no sense and must be changed”), then alarm bells should be ringing.
After all – if you can’t agree now when everybody’s getting along, what happens if all hell breaks loose?
Special Purpose Vehicles
It’s not uncommon for developers (who, helpfully for them, have no financial licensing requirements) to form a special purpose vehicle for a project.
The result is that you’re dealing with a company that has $2 in equity and a colossal loan with a bank.
If they simply decide not to pay you, or the bank valuation doesn’t come up to scratch half way through the project, the chances that you could take any kind of fruitful action to get your money are extremely slim.
If your retention money was spent on beer last Friday night, then that’s tough cookies. You’re left suing a shell of a company to get the leftovers after the bank has taken everything plus default interest.
The problem is that SPVs are fairly common, and so that in itself isn’t a good reason to leave the deal alone. But who stands behind the SPV, and can you get any form of comfort from the underlying stakeholders? Do they demonstrate any of the other issues we’ve highlighted here?
What’s the Security Position?
A quick check of publicly available information will show you the security position of the people you’re dealing with.
The chances are that you’ll be unsecured, which means that in the event of an emergency the bank and any secured creditors will be first in line to collect their debts.
You might not be able to fix that, but you can take a look at which lenders they are using. Major banks? Second tier? Bridging finance? People you’ve never heard of?
If your client can’t get finance from a decent financial institution, that might well mean that the better known lenders won’t touch them. Which means they are considered risky.
If the banks don’t want the exposure, despite the fact that they have first ranking securities, then what kind of risk does that mean for you as an unsecured creditor?
In Short – Use your Judgment
Like many negotiations, there simply aren’t hard and fast rules.
But as the risk piles up, you need to make a call about how much you are comfortable dealing with, and just how many things would need to go wrong for the job to become a huge loss rather than a tidy profit.
If in doubt – ask questions, run hypotheticals, or ask your friendly neighbourhood construction lawyer.