Construction Contract Fundamentals. Baker Tilly refers to Baker Tilly Virchow Krause, LLP,

Transcription

1 Construction Contract Fundamentals Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International Baker Tilly Virchow Krause, LLP

2 About Baker Tilly > Established in 1931 > 16th largest accounting and advisory firm in the United States* According to Accounting Today s 2011 list of Top 100 Firms. > More than 1,300 professionals > Baker Tilly Virchow Krause, LLP is the largest U.S. Baker Tilly International ti independent d member firm > Baker Tilly International is the eighth largest public accounting network with representation in more than 110 countries > Convenient, seamless resource for worldwide needs 2

3 About Baker Tilly From concept and funding to controls and compliance, Baker Tilly has more than 250 dedicated construction and real estate industry professionals to assist with your facility development project through all stages of the development lifecycle. 3

4 Introductions Tony Ollmann Erik Schuchardt CCA, Director CPA, Manager

5 Overview Today s Topics: Professionals in Construction Activities Construction Lifecycle Owner s Responsibilities Contracting Methods Key Risks Contract Provisions 5

6 Polling Question #1 Why are you here today? A. To enhance my knowledge of construction contracting B. Because my organization has a major upcoming construction project C. I am interested in learning more about how I can contribute to upcoming construction projects at my organization D. Construction ti contracts t are unique and I m curious to learn more! Please respond using the polling section in the WebEx screen to the right. 6

7 Construction Lifecycle Insert graphic from word doc *Architect/Engineer (A/E) 7

8 Construction Project Management Team Owner Owner s Representative Internal Audit or Other Compliance Representative Office of General Counsel Architect Construction Manager Other Groups and Stakeholders. Internal & External 8

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10 Polling Question #2 How familiar are you with construction terminology? A. Very familiar; I could have a fast paced conversation with my construction team B. Familiar; I would benefit from a brush up on key terms and risks C. Unfamiliar with key terms and risks Please respond using the polling section in the WebEx screen to the right. 10

11 Key Terms Competitive Bid Negotiated Master Services Agreement 11

12 Key Terms Contract Types: Lump Sum (Stipulated t dsum or Fixed dpi Price) Guaranteed Maximum (GMAX or GMP) Unit Price Time & Material Cost Plus Fixed Fee or Cost Plus Percentage Fee 12

13 Key Terms Contracting Methods: Competitive Bid Negotiated Construction Management at Risk Construction Management Not at Risk Prime Contracting Direct Contracting 13

14 Key Terms Project Delivery Methods: Design Bid Build Design Build Integrated Project Delivery 14

15 Key Terms Financial Terms: Labor Burden Rates Overhead Rates General Conditions Procurement Burden and Mark-Up Overbilling Aggressive e Billing Value Engineering 15

16 Construction Lifecycle: Feasibility and Design Key Risks of This Stage: Stakeholder identification Architect selection Delineation of needs and wants Conflicting pragmatic and political objectives Note: Architects and engineers are not typically bid but are selected based upon their technical qualifications 16

17 Polling Question #3 Which contract method is most used with projects greater than $10M? A. Lump Sum B. Cost Plus C. Unit Price D. GMP/GMAX Please respond using the polling section in the WebEx screen to the right. 17

18 Construction Lifecycle: Feasibility and Design Example: A recently constructed t medical research facility ($300M) delayed construction so the design team could collaborate with the mechanical, electrical and plumbing professionals. This resulted in: 10% reduction in overall construction costs Projected operating costs 12% below budget Optimum building workflow Community buy in and support for the building. 18

19 Construction Lifecycle: Contractor Selection & Due Diligence Key Activities of This Stage: Establish technical qualifications (facility s responsibility) Assemble bid package with specifications (facility s responsibility) Request financial package Credit report Credit references Audited or reviewed year end financials Current financials Work in Process (WIP) schedule Backlog schedule List of recent layoffs 19

20 Construction Lifecycle: Contractor Selection & Due Diligence Key Activities Continued: Indicators of financial i weakness Significant changes in owner s equity Weak cash position Repeated late payments to suppliers Outstanding and recent contractor s liens Refusal to supply financial information, especially if it is the current tfinancial i statement t t Mitigation strategy: Request a performance bond. The bond underwriter will also closely examine the financial strength of the contractor t before underwriting the project. Caution: Performance bonds don t mitigate all of the risks! An owner will not be reimbursed for time delays, cost of rework, additional internal efforts, or cost of capital. 20

21 Construction Lifecycle: Contractor Selection & Due Diligence Key Risks of This Stage: Selecting a contractor t that t is unqualified or does not have the financial stability to deliver the project and support its warranty obligations Example: A financially weak contractor may result in suppliers and subcontractors not getting paid. The impact to the owner is significant: Liens against the building may prevent occupancy Construction delays until subcontractors and suppliers are paid Reluctance or refusal by professionals to work on the project Lost discounts and credits, even late payment penalties Impact to the owner s credit rating 21

22 Construction Lifecycle: Contracting Key Activities: Determining i contract t method Negotiating contract terms, conditions, and provisions Risks: Paying too much for the building Restricting the owner s ability to control financial risk Empowering the contractor to legally take advantage of the owner 22

23 Construction Lifecycle: Contracting Determining Contract Type Lump Sum: Usually less than $10 million Facility is fully designed Designs are simple and often a duplicate of another facility There are fewer unknowns that lead to change orders Benefits: Known financial commitment Less owner s administrative burden Less risk of scope creep and budget overrun 23

24 Construction Lifecycle: Contracting Determining Contract Type Guaranteed Maximum Price (GMP) Usually used on larger projects Project nature is complex with unknowns Often coupled with a concurrent design process Benefits: Establishes a not-to-exceed price Enables the owner to benefit from value added engineering, price reductions, and well managed procurement Enables the owner to select and contract with the contractor while still designing the facility 24

25 Construction Lifecycle: Contracting Determining Contract Type GMP Continued Disadvantages: Requires a more complex contract that specifies as much as possible Burdens the owner with more project management and administration Project complexity leads to more opportunity for aggressive or abuse behavior Contractors like to believe that their budget is the entire maximum price 25

26 Construction Lifecycle: Contracting Determining Contract Type Cost Plus or Time and Material Contracting Usually found in highly hl complex and very large projects or extremely small maintenance projects Unable to determine or estimate the overall project cost Projects typically last many years Used on projects like nuclear power plants and refineries Advantages Enables an owner to segment a very large project into multiple smaller projects Advances the construction timetable so that progress is made on simple phases while engineering continues on more complex phases 26

27 Construction Lifecycle: Contracting Determining Contract Type Unit Price Contracts: Typically used in a utility setting or type of service Limited application, used on projects like underground piping and road construction These contracts establish a rate price for each type of service to be delivered The delivery yquantities may or may not be known Unit price for each segment of work includes all direct and indirect construction costs Advantages: High degree of control over scope and pricing Change orders are easier to calculate 27

28 Construction Lifecycle: Contracting Starting point: American Institute of Architect (AIA) Contracts AIA written to favor the architect and contractor, not the owner and should only be considered a starting point 28

29 Construction Lifecycle: Contracting Contract Provisions Provisions that apply to all contracts: Change order process for scoping, pricing, i and approval Process for handling owner allowances and credits Process and pricing for reduction in work scope Process for using and reporting contingency budget Progress reporting Business ethics and professional conduct Insurance, guarantee, and warranty requirements Right to audit clause 29

30 Polling Question #4 Why are change orders inherently more risky than other construction events? A. Scoping and approval occur quickly B. Minimal documentation C. Little to no competitive pricing D. All of the above Please respond using the polling section in the WebEx screen to the right. 30

31 Construction Lifecycle: Contracting Contract Provisions Change order provisions should include the following: Definition of major and minor change order Authority for approving each type of change order Authority for using contingency budget Change order documentation 31

32 Construction Lifecycle: Contracting Contract Provisions Change order documentation should include: Who is performing the work Cost breakdown of materials and labor with quantities and rates for each Contractor markup Clear description of the scope of work Clear description of why the change order is necessary 32

33 Construction Lifecycle: Contracting Contract Provisions Example $6 million renovation project Design change necessitated $750,000 of additional electrical work Construction contract defined change order approval, contractor billing rates and markup on materials. Subsequent change order review uncovered markup had been taken on materials and labor. Contractor refunded the owner $46,

34 Construction Lifecycle: Contracting Contract Provisions Provisions that are most applicable to GMP and Cost Plus: General conditions fees and definition of what this covers Construction management fee and definition of allowable and non-allowable construction costs in the formula Self-performed trade and craft costs Trade, craft, and professional rate schedules Allowable pass through expenses 34

35 Construction Lifecycle: Contracting Contract Provisions Costs typically included in General Conditions: Job site trailer and utilities Winter conditions Small tools charge Project manager and principal labor charges Administrative i i and overhead costs Layout yard and construction material storage Value engineering g Accounting and project reporting 35

36 Construction Lifecycle: Contracting Contract Provisions Costs that are not typically included in General Conditions and are the Owner s responsibility: Insurance General foremen and supervisory costs Pickup trucks and transportation Construction material purchasing and transportation Computer and office equipment 36

37 Construction Lifecycle: Contracting Contract Provisions Provisions that are most applicable to GMP and Cost Plus: Established labor and overhead burden rates Shared savings calculation Self-performed f work Bidding Pricing Reporting 37

38 Construction Lifecycle: Contracting Contract Provisions Labor Burden: Labor burden is the incremental cost employers cost to carry an employee on the crew. Typical labor burden costs are: Employee benefits Employers social security Workman s compensation insurance Health and safety Federal and state unemployment tax Union assessments (pension, training, etc) 38

39 Construction Lifecycle: Contracting Contract Provisions Labor Burden should not include: Contractor t markup or profit margin Overhead allowance Vehicle allowance Tool allowance Union dues 39

40 Construction Lifecycle: Contracting Contract Provisions Labor Burden risks: Overcharging for allowable burden costs Charging for non-allowable costs Double charging g for costs also covered by general conditions Double charging for costs that are specific pass through expenses 40

41 Construction Lifecycle: Contracting Contract Provisions Shared Savings Calculation This is an incentive program mutually agreed upon between the owner and contractor to share in savings that arise from: Value engineering Aggressive purchasing strategies Contractor s supplier relationships Shared savings risk: Materials that are commodity priced should be excluded d from the shared savings calculation. l 41

42 Construction Lifecycle: Contracting Contract Provisions Self-Performed Work Trade and craft construction ti that t is performed by the prime contractor. Typical self-performed trades include: site preparation, concrete footings, floors and walls, wall framing, drywall finish, trim and finish. Self-performed work should be competitively priced with a separate pricing and scoping document explicitly defining scope, rates, materials and pricing method. 42

43 Construction Lifecycle: Bidding Key Risks: Donations and contractor t preference Unethical bidding practices Kickbacks Courtesy bids and not competitive bids Example: The prime contractor is also a concrete and masonry contractor and intends to bid on this phase of work. The other subcontractors in the market don t believe that they will have a legitimate chance to win the work and don t submit their best price for the work. The prime s bid is lowest and they are awarded the concrete work, even though this may not have been the lowest price achievable. 43

44 Preconstruction Planning and Due Diligence Action Items: Establish contracting ti goals and objectives Establish development team s roles and responsibilities Determine subcontracting methodology Develop contractor qualification criteria Establish bidding process 44

45 Preconstruction Planning and Due Diligence Action Items: Develop bid award criteria i Develop owner communication requirements Develop pproject performance reporting requirements Develop project cost and financial reporting requirements Develop owner s right to audit requirements 45

46 Additional Contract Provisions Project performance reporting Earned value reporting Cash requirements forecasts Construction schedule Budgeted costs to actual Estimate to complete forecast Reporting requirements should include: Delivery deadlines Content Format 46

47 Additional Contract Provisions Pay Application (Invoice) Documentation Each month the pay application should be accompanied by: Material invoices and receiving tickets Time sheets for self-performed work Subcontractor invoices Equipment logs for contractor provided equipment Lien waivers Equipment rental invoices 47

48 Additional Contract Provisions Contractor Payment Terms Typical terms require the owner to pay the contractor t within 30 days of the pay application invoice. Consider the follow modifications: Payment period begins on the acceptance of a complete pay application, not the pay application date Consider owner direct payment for major material purchases 48

49 Right to Audit Language This must be reviewed by your legal counsel prior to implementation: Right to Audit Availability of Records. The records of the parties to this Agreement relating to the Project, which shall include but not be limited to accounting records (hard copy, as well as computer readable data if it can be made available; subcontract files (including proposals of successful and unsuccessful bidders, bid recaps, bidding instructions, bidders list, etc); original estimates; estimating work sheets; correspondence; change order files (including documentation covering negotiated settlements); backcharge logs and supporting documentation; general ledger entries detailing cash and trade discounts earned, insurance rebates and dividends; any other supporting evidence deemed necessary by Owner to substantiate charges related to this agreement, and all other agreements, sources of information and matters that may in Owner s reasonable judgment have any bearing on or pertain to any matters, rights, duties or obligations under or covered by any contract document (all foregoing hereinafter referred to as Records ) shall be open to inspection and subject to audit and/or reproduction by Owner s representative and/or agents of Owner. Owner may also conduct verifications such as, but not limited to, counting employees at the job site, witnessing the distribution of payroll, verifying payroll computations, overhead computations, observing vendor and supplier payments, miscellaneous allocations, special charges, verifying information and amounts through interviews and written confirmations with employees, Subcontractors, suppliers, and contractors representatives. All records shall be kept for seven (7) years after Final Completion. 49

50 Right to Audit Language Right to Audit Continued: Flow down. CM/GC and Architect shall require that all of their payees (including Architect s Consultants, Subcontractors and Suppliers) comply with the provisions of the Right to Audit article by incorporating these requirements in all written contracts. This requirement to include flow down right to audit provisions in contracts with payees shall also apply to Subcontractors and Sub-Subcontractors, Subcontractors and Suppliers. CM/GC and Architect shall cooperate fully and will request all of their payees to cooperate fully in furnishing or in making Records available to Owner, provided, however, the CM/GC and Architect shall not be responsible for any failure of Architect s consultants, Subcontractors or Suppliers to comply with recordkeeping requirements after the date of Final Completion. 50

51 Baker Tilly Webinar Series Coming up in the Understanding Construction Contract Controls and Construction Audit Best Practices Webinar Series: Construction Financial Controls and Contract Compliance Wednesday, October 12, :00 p.m. Central Post-Construction Auditing and Fraud Detection Wednesday, November 9, :00 p.m. Central Register at bakertilly.com/construction-audit-webinar 51

52 Additional Resources theiia

53 Any Questions? Please feel free to ask questions in the screen to your right. We will answer as many questions as time permits. 53

54 Contact Information Tony Ollmann Erik Schuchardt