Sunday, January 7, 2018

Negotiating Contract Terms

by Ilse Baeck, Owner of Contract Review Services for Construction

"Everbody signs our contract..."  If you are a subcontractor, this probably sounds familiar to you. Another oldie, but goody: “We do not allow changes to our boiler plate.” I consider both to be opening statements to negotiations.

As a general contractor you face similar situations. The competition on the top is fierce. And owners don’t miss a chance to alleviate their risks. Lately, design-build contracts are used to put responsibility for the architect, chosen by the owner, on the general contractor. And subcontractors, who are the essence of every project, who bring expertise, who do most of the work, and who basically finance the whole building project, are expected to assume all the risks as well.

If you, as the subcontractor, insist on getting the terms changed, you will find that most general contractors are willing to talk. General contractors will agree to negotiate for very good reasons:
·         They used your number to prepare their own bid for the owner,
·         They selected you, because you were either the lowest bidder or had the most solid and comprehensive estimate,
·         You have a good reputation in the industry and most likely are financially strong.

The last thing any project needs is a contractor going broke in the middle of it. Not negotiating with you means that the general contractor must now hire the second-best choice. That second choice subcontractor’s bid might have expired, their price might have gone up.  Plus, the owner may not approve a substitute.  It is a lot more headache for the general contractor to be rigid than to sit down with his top choice and negotiate.

Incidentally, the same is true for the general contractor. The owner will agree to negotiate for all the same reasons:
·         You have the best number
·         You have the best reputation
·         You are financially solid
·         You have most experience with the kind of project the owner wants you to build.

I remember meeting with a general contractor’s team in which their opening was “nobody else had a problem with our contract; you are the only one.” A half hour into the meeting, the main negotiator turned to his associate and announced “on this change, let’s use the same wording we did with that other sub.”  Aha! Nobody else asked for changes, right?

Sometimes reading a contract can be frustrating; for example, when allowances for deductions are listed within the billing requirements.  Who would expect them there?  Or when you are asked to indemnify the owner or the general contractor for their “whole omission and/or fault.” Personally, I love to ferret out the little and the big pitfalls that can cost a contractor a lot of money. If you look at it that way, it might become fun for you, too. Of course, these documents are prepared by lawyers and it does not mean that the person presenting them is not a good and decent customer. However, even the best customers get off the straight and narrow when they themselves risk losing money. For that reason, protections written into the contract are immensely important.

The best advice for a good outcome of any negotiation is to listen. Listen most of the time and once you hear all the reasons that your customer insists on a certain clause, offer a solution that works for both sides, changes the wording and spreads the risk evenly. It is also important to put not only the absolute deal breakers on the table. Be very detailed and mark absolutely everything you don’t like. That way, your negotiation ends with mutual wins and losses. Customers always need to know that you have their best interest in mind, but that you also need to have some basic protections for yourself in place. And in the end, once you have negotiated your contract, you have earned the customer’s respect.

In summary, I want to encourage everybody to negotiate, negotiate, and negotiate. There is a saying in the construction industry that there will always be jobs that lose money.  It does not have to be that way! With the inclusion of agreed-upon terms that will protect you, before the project even begins, you will be more likely to walk away with profit once it’s completed.

Friday, December 29, 2017

Best Summary of Current Tax Law vs. New Tax Law

One week ago the President signed the Tax Cuts and Jobs Act.  Northern Trust published an excellent summary of the new law, laying out in easy to read tables the law as it stands currently in 2017 and the new law effective next week in 2018.  The piece covers Pass-Through entities, Corporations, Individuals, Estates/Gifts, etc.  It is by far the best summary I've seen, please see below and Happy New Year to all!

Wednesday, December 20, 2017

Tax Reform Package - Let the Games Begin

Some states, including California, are already beginning to work with tax strategists to identify methods to mitigate the impact of the loss of the state and local tax deductions for federal tax purposes.  The governors of high income tax states such as California, New York and New Jersey are in close contact with one another to work towards a solution for higher income tax payers who may be hurt by the loss of these deductions and they are already coming up with some creative workarounds.

One option being considered is to completely eliminate the state income tax system and replace the lost revenue via increased payroll taxes.  States would tax corporations an amount approximating how much state income tax an employee would have paid under the current system.  This would allow corporations to get that lost tax deduction transferring it from the individual to the corporation and enhance revenue in these states.  I do wonder about possible fallout from unintended consequences here, what moves corporations may make in response.

Another option on the table for these states is to allow public school systems to be recognized as 501(c)3 organizations.  The thinking here is that the portion of property taxes, currently slated to be capped along with state income taxes on a combined basis at a $10,000 deduction on your federal tax return, relating to schools would be allowed as a charitable deduction.  That’s a very creative solution to help individual taxpayers get over the new and increased standard deduction limits slated at $24,000 for joint returns, $18,000 for single parents and $12,000 for individuals.

Also, some governors are already investigating possible legal action against the Federal government under the premise that this tax reform package violates the protection of states’ rights under the U.S. Constitution.  So sit back, open a bag of popcorn and continue watching as certain states maneuver and assess what actions they might be able to take to help preserve some of the status quo with respect to these state and local tax deductions.

Monday, December 11, 2017

Overview of Proposed Tax Reform

By now most have heard about some of the proposed tax changes coming out of Washington, D.C.  There are some differences between what the House is proposing vs. the Senate and The Associated General Contractors of America have prepared a nice table showing those differences.  The chances are very good at this point that we will see reform for 2018, a little over 30 years after we saw the last major overhaul.

The changes will be widespread, affecting corporations and individuals alike.  Of special note for the construction industry are the following:

  • ·         Repeal of the Domestic Production Activities Deduction (DPAD)
  • ·         Small Contractor Exemption Increase from $10MM to either $15MM or $25MM

Also, Cash Accounting will be available up to either $15MM or $25MM in gross receipts (currently $10MM for Pass-Throughs and $5MM for C-Corps), including inventories.  Both the House and Senate have provisions for full expensing of new equipment (the House includes used equipment here as well) for 5 years.

There is a lot of change on the horizon, much of it should bode well for businesses and the economy.  Should you wish to discuss any of these provisions further, their possible impact and what actions might be advantageous as we head into 2018 please feel free to contact me.  Given some or most of these changes will be occurring, there are measures to take to position your business for the maximum benefits.  For a more detailed overview of the proposals in the House and Senate, see below.  

Tuesday, November 7, 2017

Current Outlook and Architectural Billings Index

One of the questions I’m often asked is “What do things look like out there?”, typically followed these days with “How long will these better times last, when will it end?”.  Every contractor has their own experiences, their own challenges and successes.  The generic answer needs to address the “typical” experience out there, the contractor who falls somewhere in the middle of the bell curve.

The answer I give today is things are generally pretty good out there, not as euphoric as it was just prior to the great recession, circa 2006 or 2007) but increasingly good in recent years.  My perspective is that things bottomed out, for the average private commercial/industrial contractor, sometime in 2012.  Each year since 2013 we’ve seen further modest improvement, stabilization and good earnings for contractors here in Southern California.

Frankly, a few years ago, I thought based on listening to economists and others that 2017 might be the peak and we’d fall off from there for a while.  Well we are within a handful of weeks from getting out of 2017 and things still look pretty good.  Backlogs are strong into 2018, with some of my clients reporting commitments into 2019. Business optimism remains strong.    Of course a large geo-political event could put work to a halt like we saw after 9/11, commitments notwithstanding.  That being said, it looks like we have good times for the foreseeable future and we can only hope it continues.  

The concept of "reversion to the mean" creeps into my mind as we currently enjoy the 3rd longest economic expansion in U.S. history.  Hopefully the Federal Reserve and others whom have control over how our economy behaves pull on the all the appropriate levers in all the right ways at all the right times, or something close to that metaphor.

A quick look at the Architectural Billings Index, a leading indicator we’ve touched upon a number of times over the years on this blog shows that here in the West, things appear to have softened some with a reading of 48.4 for September 2017.  These numbers are just indications of work to be performed, more of a guideline than a rule.  If you aren't familiar with how the index works, click on the link in the preceding sentence for more background.  One poster on the AIA website from the West indicated that a few of their projects were put on hold, citing rising construction costs and labor shortages.  Interesting, makes sense given the data out there, particularly with the historically low unemployment levels we are currently experiencing.

These regional numbers for September 2017 are shown in the table below:

September 2017

By contrast, taking a look back to July 2014 numbers, we see the following:

March 2013


Perhaps the lower input costs for materials in 2013 as well as the more available labor market created conditions for increased construction activity, correlating to our experiences in 2013 and the ensuing years.  At that time, the unemployment rate quoted by the Bureau of Labor Statistics for March 2013 in the West was 8.3%, the highest in the nation with supply of labor more available than today.

Could the current labor market and the implied labor shortages be a precursor to slowing construction activity?  Or possibly stable construction activity with increasing prices?  Inflation in construction inputs could also be a factor to watch.  For the immediate future, it seems to be steady as she goes.  

The actionable takeaway from this data is to always be vigilant regarding your fixed overhead, keep it low and be prepared to make dispassionate decisions regarding your variable costs, including your labor.

Sunday, November 6, 2016

LA Stadium Project - Marquis Projects, To Pursue or Not Pursue

The much anticipated Inglewood stadium project plans are well underway, and with that the construction marketplace resources required to execute on this $2.6 billion dollar project will be spread that much thinner.  The stadium itself is expected to be completed in 2019, with all the surrounding development (labeled a “mini-city” by some) expected to be finished by 2023.  Many contractors will eagerly pursue work on such marquis projects leaving limited resources in the market to conduct other, recurring construction activities.  This drawdown on the supply of construction resources to the LA stadium project, as well as a host of other larger high profile projects online or soon to come online, could be a support for the pricing of all other projects.  This is welcome news for the southern California construction economy.

Contractors who work on marquis/trophy projects most certainly have the privilege of saying they worked on XYZ project.  What I've seen over the years is often times, in the final analysis, the financial performance of those projects doesn’t work out quite as originally planned.  Contractors may end up “paying” for the right to say they worked on a special project.  That payment is only financial, the stress involved in executing these large projects is not measured in dollars.  Why do these projects, in some cases, not turn out as originally planned?  For starters these contracts aren't the type typically executed by the contractor.  The factors involved are usually different than most every type of job a contractor has ever done before.  Additionally, sometimes the owners of these projects can be very tough on changes, having the attitude that the contractor is “lucky” to be associated with such a name brand company/project.  Generally, the contractor just bit off more than they could chew.  The technical challenges could be new,  perhaps it's their largest contract ever, or working in a new geography they weren’t familiar with or able to effectively manage.

With the above being said, one strategy might be to steer clear of the stadium project and focus on other opportunities.  Like I mentioned, there may be a built-in support for pricing giving the supply/demand impact the stadium project is likely to have on construction resources.  It might be worthwhile to not participate on the stadium project and do other work which should have good pricing opportunities. 

Some contractors I’ve spoken with have relationships with large contractors already committed to the project and consequently, will also need to work on the project due to that relationship.  Those cases are fine as long as the history generally supports that the smaller contractor will be taken care of in a fair manner.

I am not saying that a contractor should not consider pursuing large, trophy projects.  I am saying to carefully measure the opportunity, reconcile it with your capital (including bonding capacity utilization) and personnel structure, capacity, skillsets, and your other backlog.  Also consider the opportunity cost regarding other potential projects if you don’t take on such a large contract.  Although it may be more expensive to administer ten $2MM projects, the concentration risk associated with executing one $20MM project could be too great.  So consider whether it makes sense to pursue a large, marquis project…especially if it is different than anything you’ve done before.  Remember the old saying…”discretion is the better part of valor.”

Sunday, November 15, 2015

Piece-Rate Compensation - AB 1513 and its impact on contractors

On October 10, 2015 Governor Brown signed AB1513 into law.  The modifications to employment law that AB1513 made deal with workers’ compensation and piece-rate compensation.  This post addresses the latter.

A few industry associations asked a law firm to provide an opinion of the new law as it relates to piece-rate compensation.  The law firm did an excellent job addressing the various points of the new law.  You can view their memorandum here.  Their memorandum outlines the “safe harbor” provisions contractors will need to comply with, by December 15, 2016, in order to avoid fines and penalties.  The changes required by the new law may prove costly for contractors whom have historically compensated their workers on a piece-rate basis.  At a minimum, changes to how these contractors compensate their employees in California appear to be on the way.

A significant element of the changes have to do with contractors being required to pay workers for rest and recovery periods and other non-productive time.  The administrative requirements being imposed by this new law all but assure the demise of piece-rate pay, at least as it has been known historically.  If you have been compensating workers on a piece-rate basis and you want your voice to be heard regarding these changes, I suggest either connecting with an industry association (as referenced in the memo linked above) or contacting your local state representative directly.  In the meantime, you need to become aware of the issues and requirements surrounding the new law and act accordingly.