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Elements of contractor failure

Elements of contractor failure

In evaluating a sample of contract surety claim matters over a 10-year period, the following were identified as elements of contractor failure. Elements were identified at the time of the claim and are listed by frequency. There are many cases in which multiple elements were cited in any given instance.

1.Market focus – 53%

  • Geographic expansion
  • Change in project owner sector
  • Working for unfamiliar obligees
  • Change in project type

Has the company:

  • Undertaken a project outside of its established geographical footprint?
  • Undertaken work in a new sector?
  • Undertaken work for new and/or unfamiliar obligees?
  • Experienced significant changes in macroeconomic environment?

2. Internal controls capability – 47%

  • Operational growth exceeds balance sheet growth
  • Increase in size of jobs
  • Do the company’s internal control systems have the capacity to provide accurate, timely, and essential information to personnel?
  • Is the company able to fully utilize the primary components of the internal control systems and are they able to fully utilize the expanded components?
  • Is the company able to demonstrate proficiency with its internal controls systems? For example, can a project manager produce a progress report on a job on short notice?

3. Continuity of business operations – 47%

  • Changes in management or key personnel
  • Changes in ownership structure
  • Lack of financial and operational continuity planning
  • Has there been a change in a key leadership position such as CFO or operations manager?
  • Is there a qualified person in place to fill the vacated position?
  • Has there been a change in the company’s ownership structure?
  • Has the company developed a plan for operational or financial continuity?

4. Overextension of business operations – 32%

  • Operational growth exceeds balance sheet growth
  • Increase in size of jobs
  • Has the company demonstrated a pattern of undertaking larger and/or more complex projects?
  • Do the most recent annual revenue growth rates exceed “established” growth rates over the past several years?
  • Are increases in project contract values better explained by market forces such as cost of labor and materials, as opposed to a general appetite for larger projects?

5. Subcontractor risk management – 27%

  • Subcontractor prequalification
  • Management approach
  • Does the company use a risk-management process that’s in line with the portion of work subcontracted?
  • Is the company able to adequately prequalify key subcontractors? (e.g., subcontracts greater than X dollar amount or % of project value)
  • Does the company employ adequate resources to manage subcontractors in the field?
  • Does the company employ a subcontractor bonding policy? (e.g., subcontracts over a specified dollar threshold, etc.)

Emerging elements of contractor stress

  • Methods of Procurement
  • Supplier concentration
  • Supplier geographic location(s)
  • Documented delays
  • Modes of transportation to final destination
  • Potential impacts on:
    • Quality of work
    • Productivity
    • Labor costs used to estimate work
  •  Increased healthcare costs related to an aging workforce
  •  Impact of COVID-19
  • Significance varies depending on proximity of the contract with the owner.
  • Examples of potentially problematic clauses:
    • Extended warranties
    • Overly broad indemnification clauses
    • Conditional payment clauses (“pay when/if paid”)
    •  “No damage for delay” clauses
    • Onerous change order provisions
    • One-sided dispute resolution clauses

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