Trade contractor default on a GMP, and what reaches the owner

Trade contractor default is, on paper, entirely the general contractor problem. The owner has one contract with one party and that party is responsible for the people it hired. In practice a trade contractor failure reaches the owner through three routes, and the guaranteed maximum price does not close any of them.

The three routes to the owner

The first is time. Replacing a trade contractor takes between six and sixteen weeks in practice: demobilization, assessment of what was actually completed, re tendering, award, remobilization and the learning curve of a new team on a partly built scope. Some part of that delay will be argued as excusable, and the argument is stronger where the failure was caused by market conditions rather than by anything the general contractor did.

The second is the contingency. The contractor contingency is meant to absorb exactly this event, and on many projects it is the largest single thing that contingency is sized for. Where it is drawn down by a default in month eight, it is not available for the rest of the job, and what happens after it runs out is a question the contract answers in a sentence most owners have not read.

The third is the shortfall. Where the replacement costs more than the remaining balance plus whatever security was held, somebody funds the difference. Under a true guaranteed maximum price that is the contractor, up to the guarantee. Where the guarantee has already been eroded by changes, allowances and shared savings arithmetic, the position is less clean than it appears.

None of these is exotic. On projects between ten and a hundred and fifty million dollars, a trade contractor failure somewhere in the chain is a normal event rather than a rare one.

What security actually exists behind each trade

Three mechanisms are common and they are very different in what they deliver.

Trade contractor performance bonds. A surety guarantees completion of that trade scope. Strong protection, slow to realize. Sureties investigate before they pay, and the process routinely takes months during which somebody has to fund the work anyway.

Trade contractor default insurance. The general contractor carries a policy covering defaults across its subcontractors. Faster than a bond because the contractor controls the response, but it carries a substantial deductible and a co payment, and the first portion of every loss sits with the contractor rather than the insurer.

Nothing. On a great many trade packages, particularly below a threshold the contractor sets internally, there is no bond and no policy. The security is the contractor balance sheet and the retainage held.

The owner question at signature is not which mechanism is better. It is which trades have which, what the thresholds are, and whether the trades carrying the most schedule risk are inside or outside the protected group.

That list is a short document and it is almost never volunteered.

What a trade contractor default does to the buyout

A default in month eight is not re priced at month one rates. It is re priced at month eight rates, for a partial scope, under time pressure, by bidders who know all three of those things.

The premium is real and it is usually between ten and twenty five percent on the remaining scope, before any acceleration.

It also interacts badly with the buyout position. Where the failed trade was bought early at a keen number, that number was part of what made the guaranteed maximum price work. Replacing it at market removes the saving, and where a shared savings clause exists, it removes the owner half of a saving that has already been reported.

The mechanics of how the buyout gap moves through a guaranteed maximum price are set out in the buyout process and what the gap tells you, and a default is the most abrupt version of that movement.

There is a second order effect worth naming. A trade in difficulty usually slows before it fails, and the slowing looks like ordinary underperformance for two or three months. The buyout log and the payment applications show it before the failure does.

A worked example

A 96 million dollar mixed use project. The curtain wall package, bought at $11.4 million in month three, is with a fabricator that files for bankruptcy protection in month fourteen with roughly 40 percent of the scope delivered.

The package was below the general contractor bonding threshold and sat under a default insurance policy with a $500,000 deductible and a 10 percent co payment.

Replacement, at month fourteen, for a partial scope with existing shop drawings of uncertain status, is tendered at $9.2 million against a remaining balance of $6.8 million. Direct shortfall $2.4 million.

The insurance responds to part of it after the deductible and co payment. The contractor contingency, already at 70 percent drawn, absorbs what is left until it is exhausted.

The owner ends up carrying $2.1 million between the exhausted contingency, the 62 days of delay and the acceleration bought to recover part of it.

Every document said the trade contractor default was the contractor risk. The arithmetic said otherwise once the contingency was gone.

Five things to settle before signature

Get the list of which trades are bonded, which sit under default insurance, and which have neither, with the thresholds that produce the answer.

Read what happens when the contractor contingency is exhausted. Whether the guarantee still holds, what the owner is then exposed to, and whether a default counts as a contingency event at all.

Ask for financial prequalification on the three or four trades that carry the schedule. Steel, envelope, elevators and major mechanical are usually the list, and a contractor that has prequalified them will have the file already.

Check retainage on trade contracts against retainage on the prime. Where the contractor releases trade retainage faster than the owner releases its own, the security behind each trade is smaller than the headline number suggests.

Size the contingency against the named events rather than as a percentage, which is the argument in how much contingency is enough. A trade contractor default is one of the few events large enough to matter on its own.

None of these five requires the contractor to do anything unusual. All five are questions about documents that already exist, and a contractor that has run a proper prequalification process will answer them in an afternoon.

A contractor that cannot answer them has not run one, which is itself the finding, and it is worth knowing before signature rather than in month fourteen.

It is also worth asking what the contractor does when a trade starts to slow, because the answer describes a process rather than a document. A contractor that describes supplementing the crew at its own cost, holding weekly manpower reviews and escalating to the surety early has thought about it. A contractor that describes terminating and re tendering has described the expensive version.

The difference between those two answers is usually worth more than the difference between a bonded and an unbonded package.

A final point on timing. Prequalification files go stale quickly in a volatile market, and a financial statement dated eighteen months before award says very little about a trade contractor position today. Where the package is large and the award is late, asking for current figures at award rather than at bid is a reasonable request and an informative one.

What we do

We ask for the security position trade by trade, read what the contract does when the contractor contingency runs out, and price the exposure on the packages that carry the schedule. Where a trade is already slowing, the payment applications and the buyout log usually show it before anybody says so. The work is the schedule and procurement risk review. Where a claim is already on the table, dispute and claims support works from the same records under the direction of your counsel.

Questions people ask