Avoid Risk Working with Contractors

The amount of money you spend paying a contractor to perform small repairs, improvements or major construction-related projects could be small compared to potentially greater costs resulting from a dispute with the prime contractor or any of the subcontractors they hire. Stricter laws and regulations offer some protection against unlicensed contractors; however, if you are like many small business owners, you may not know what questions to ask or what resources are available to you to help you screen contractors during the bidding process. To help us understand what we can do to avoid the risks associated with working with contractors, we are happy to be joined once again by attorney Virginia Suveiu, specializing in commercial and contract law and developer of the Legal Risk Management Certificate Program at the University of California, Irvine.

Questions Answered For You

  • How can we make better decisions in hiring contractors?
  • If I don’t have people who are familiar with the laws, rules and regulations, who do I call on to help me make sure that I'm doing the right thing, I'm asking the right questions, and that I’m doing my level best to manage this risk that is inherent in these types of situations?
  • What important lessons can we learn from the perspectives of prime contractors and subcontractors?  What considerations do they have to make?
  • What are just a few key points you could leave with us today with respect to prime and subcontract management, and risk management associated with these?

When your subcontractors provide a significant part not only of the work on the project but of the project success, it's completely unreasonable not to provide a commensurate level of management intention and professional subcontract management.​

- Virginia Suveiu

Key Takeaways

  • Achieving constant legal compliance in today's regulatory environment is challenging. Besides coping with governmental oversight, legal enforcement companies now face a growing array of both substantive and procedurally oriented compliance obligations imposed by their trading partners and other private organizations that they do business with, their third parties, the business partners that they do business with, which is sometimes but it's not always instigated by the government.
  • The current mentality is that being in compliance, which was considered strictly as a cost in money and in time, has now become a business imperative. Understanding compliance on the perspectives of both the prime contractors and the subcontractors is crucial in ensuring that a project will actually be completed not only on time but without any compliance-related problem.
  • Knowing with whom to speak regarding relevant laws, rules and regulations depends on the nature of contract and should be part of the due diligence.
  • It is imperative that business people, members of the C-suite and senior managers completely understand what is within the contract itself.
    • Business owners need to constantly educate themselves through industry association meetings, trade organization meetings in whichever industry they are in. 
    • Various educational organizations including the Contract Management Associations or CMA and the International Association for Commercial Contract Management or IACCM provide educational materials both for federal government contractors as well as commercial contractors, and those who work on the commercial side of contracts.
  • A prime contractor’s main consideration is not allowing subcontractors to start work until they have produced some proof of compliance, including certifications establishing, successful completion of the background checks, the drug screenings, whatever is required by the regulation and whatever the industry and the theme of the contract involves.
  • To flowdown a contractual clause or code requirement essentially is to impose it on your third party, including your subcontractors, your suppliers, down to the contracting chain. It’s typically done by requiring each link in the chain to incorporate identical or equivalent clauses within its contract within the next link down.
  • One of the most important considerations of subcontractors is that they will certainly want to request a copy of the prime contract and read it in its entirety and assess whether the flowdown applies only to their scope of work, or if it is more encompassing.
  • Consistent communication is essential to ensure that the subcontractors are aware of any new or changed policies or requirements as well as to ensure that there’s alignment of the new work orders and the subcontract work orders.

Read Full Interview

Jeff: If you're thinking about hiring a contractor as part of your company's growth or improvement projects, stop until you hear what my guest on this segment has to say. If you want to avoid unnecessary financial and legal risks working with contractors and subcontractors, you've come to the right place.
 
From our studio in Southern California, with guest experts from across the country and around the world this is “Deal Talk,” brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
 
 
Jeff: Hello, and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on “Deal Talk,” it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
 
On this edition of “Deal Talk,” we're going to talk about something that is really, really important to business owners everywhere because at some point down the line many business owners find the need when growing their businesses or expanding their current offerings or opportunities they have to make capital improvements, you probably made some yourself, or maybe added a business location, perhaps another building where you've had some large equipment installed on your property. Whatever the case may be, you need to call a contractor. That contractor will usually call subcontractors to come on out and do a number of various jobs or complete the entire project altogether. 
 
My guest today has been with us before. Her name is Virginia Suveiu, she's attorney. She provides counsel on legal risk management, regulatory compliance and commercial and international law matters including contractual law. She is also an instructor at University of California Irvine Extension for the Contract Management Certificate Program, and the Legal Risk Management Certificate Program she helped develop. And on top of all this she also serves as adjunct professor at Concordia University in Southern California. Virginia Suveiu welcome back to “Deal Talk,” it's nice to have you.
 
Virginia: Thank you very much. Always a pleasure to be here.
So compliance is becoming privatized, and compliance is really going viral.
Jeff: You have so many hats that you wear. I don't know how you manage to keep it all together, because I don't know an attorney who isn't busy with their own business. But you really do have a lot going on, and Virginia, the reason we had you back on the program is you are able to share so much with us on your first appearance on this program.
 
I know that risk management where contract law is concerned is something you work very hard to stay on top of. It seems that there's always something in the news. And particularly where working with subcontractors is concerned it seems that the risk that we all need to manage it seems to step up and in almost incrementally because you're adding extra layers of individuals and companies to these projects that we have working for our businesses.
 
And I wanted to talk with you a little bit today about how we can make better decisions about the contractors that we hire because those are the folks that are going to bring on the subs. And there is so much here at risk. Give us some background about why this has become particularly important at this time, Virginia.
 
Virginia: Of course. In fact, all of us, we wear many hats given the current economic climate, the regulatory actions that are coming down the pipe, and they're just in general. Business at this moment in time you have to be fully aware. You're on constant motion. And in fact when your subcontractors provide a significant part not only of the work on the project but of the project success it's completely unreasonable not to provide a commensurate level of management intention and professional subcontract management. Subcontract management is getting more attention now.
 
Here are a few interesting stats. Just in 2010, the US federal government awarded more than seven million contracts valued at over $531 billion to acquire products, services, systems, other solutions from thousands of government contractors, which they're the prime contractors. The US federal government prime contractors often must select and manage multiple subcontractors and comply with a tremendous number of complex laws, regulations, and policies, etc. 
 
Compounded with that I recently spoke with a colleague of mine. His name is Scott Killingsworth. He's a partner at a large international law firm Bryan Cave. What's really important is to look also what colleagues are discussing, what the academic community is discussing, what the business community is discussing.
And here's kind of the latest trend that you're really seeing private to private compliance. The privatization of compliance is something that I'd really want to discuss. It's very important. Essentially what we're talking about here is achieving constant legal compliance in today's regulatory environment is challenging and it keeps not only business people but practically everybody up at night. It's sort of that little voice that constantly nags in the back of your mind. 
 
Besides coping with governmental oversight, legal enforcement companies now face a growing array of both substantive and procedurally oriented compliance obligations imposed by their trading partners and other private organizations that they do business with, their third parties, the business partners that they do business with, which is sometimes but it's not always instigated by the government.
 
What you're seeing is that inside contract clauses and codes of conduct for the business partners, these obligations often go beyond just compliance with the law, but they also ask to ensure that you will be in compliance and to assure your partner that compliance will be certain. 
 
These contract clauses create new compliance obligations and enforcement mechanisms which touch upon the entire structure, the entire design priorities and administration of corporate ethics and compliance programs. So compliance is becoming privatized, and compliance is really going viral. If we look at the origin of this, it's very important to understand blockbuster finds, civil penalties and disgorgements, burdensome settlement agreements are real attention getters. You hear about companies with foreign corrupt practices act and the millions of dollars in fines, etc. For example, if you have certain non-prosecution agreements with foreign corrupt practices act, they send a message today by routinely requiring the defendants settling to institute the appropriate compliance process control over not only themselves but over their business associates, such as advanced due diligence and ongoing oversight.
 
So essentially you're slowing down from the prime contractor to the subs codes of conduct, you’re imposing training requirements, and securing contractual commitments of audit rights, vendor compliance undertakings, all principles which are echoed in guidance from the department of justice.
 
When I'm talking about flowdown to flowdown, a contractual or code requirement is essentially to impose on third parties representing successive links in the contracting chain such as subcontractors, suppliers, distributors, and sales agents. Ordinarily it's done by requiring each link to incorporate an identical or equivalent clause in the contract with the next link sometimes ad infinitum, or as long as it goes. 
So this is the world that we live in. Cash flow as we all know is the heart of business. So financially strapped prime contractors and subcontractors may be late paying their suppliers as a result of their financial difficulties and finding available loans, securing credit, paying higher interest rates, receiving late payment from their customers...
 
 
Jeff: And that can result obviously in the delay of a project completion at the end of the day.
 
Virginia: Exactly. All of these elements that you see, that is why it's bringing subcontract management under the microscope, because this is the atmosphere that we're currently all finding ourselves living under.
When I'm talking about flowdown to flowdown, a contractual or code requirement is essentially to impose on third parties representing successive links in the contracting chain such as subcontractors, suppliers, distributors, and sales agents.
Jeff: Well, it would seem to me, Virginia Suveiu, that if subcontract management is becoming more important and you still, in many causes, and we hear of these stories that come out from time to time, can't rely on the general contractor or in the case of our discussion today the prime contractor to ensure subcontractor compliance. It seems that the onus then is soon placed on the business owner or the customer in this case to make sure that they themselves can vet out these subcontractors, assess their qualifications, and find out if they are compliant, if they have the proper insurance, they have the proper licenses and certificates. Is that true?
 
Virginia: I know it sounds burdensome, but it's a reality now. There's a change in mentality where one's compliance and being in compliance was considered strictly as a cost in money and in time. It becomes a business imperative. There are several areas of looking at this. You can look at it from the prime contractor’s perspective. You can look at it from the subcontractor's perspective. But understanding all of the perspectives is crucial in order to be able to ensure that the project will actually be completed not only on time but without any compliance-related problem.
 
 
Jeff: Okay. I don't know exactly what questions to ask. I don't have people who are really familiar with all the rules, the laws and regulations. Who do I call on to help me make sure that I'm doing the right thing, I'm asking the right questions, and that I in fact am doing my level best to manage this risk that is inherent in these types of situations?
 
Virginia: Right. I'm so glad you pointed out the crucial importance of doing your due diligence. And due diligence also includes knowing with whom to speak depending on the nature of the contract. For example if it's a federal government contract, and if it's with a certain federal government agency, it's always crucial to have on staff contract managers, contract administrators, and attorneys to have deep familiarity and knowledge with the federal acquisition regulation which is the main body of regulations which govern federal government contracts. So that's an imperative. 
 
Another point that I would like to share with the audience, as well, apart from talking to the necessary experts depending on what the subject of the contract is as well as what your industry is. There are various educational organizations, let me give you a few. There's national contract management associations and CMA. And there's also IACCM which is the International Association for Commercial Contract Management.
 
These two organizations, and there are other professional organizations that deal with contract management have begun to put out wonderful educational material both for federal government contractors as well as commercial contractors, and those who work on the commercial side of contracts. Information about subcontract management including certain software that's out there, I'm not going to get into the names of the software but that's helpful with that.
 
But it's imperative that business people, members of the C-suite, senior managers, really fully understand what is within the contract itself. With National Contract Management Association, it's very interesting. I'm a member of a local chapter here in Orange County. And we have professionals who come and speak at our chapter meetings which are monthly, and they will speak on subcontract management, on best practices.
 
It's worth paying for the $20-$25 to go to meetings such as these and learning what is happening currently in the industry. I also always encourage people to educate themselves as much as possible through industry association meetings, trade organization meetings, whatever your industry is. You then learn what information is out there and then you're able to pick the relevant information, and then you can have a much more educated and richer conversation with your attorney and with the experts that you have there.
 
 
Jeff: There you go.
 
Virginia: Those are some suggestions and they're accessible to practically anybody.
I always encourage people to educate themselves as much as possible through industry association meetings, trade organization meetings, whatever your industry is. You then learn what information is out there and then you're able to pick the relevant information, and then you can have a much more educated and richer conversation with your attorney and with the experts that you have there.
Jeff: And it's nice to know that in fact there are resources and more coming on board from what you're saying that are available out there to anyone, business owners, anybody that they put in charge of this sort of thing to help people in working with subcontractors because we're talking about a lot of money, a lot of time, and really the potential for some real financial issues down the line and including even some legal problems when things don't go quite right. We're talking with Virginia Suveiu. She is an attorney in Orange County, California. She specializes in contractual law and risk management. She's also a professor. And my conversation with Virginia will continue when “Deal Talk” returns after this.
 
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Compliance should no longer be viewed strictly as a cause of speed bump to getting work done. It should be included as the business school as something we need to invest in because without the contract compliance, without understanding how to achieve contract risk management, you will be unable to fully achieve the project successfully.

Jeff: My name is Jeff Allen with my guest Virginia Suveiu, an attorney at large in Orange County. She is a lecturer, she's an adjunct professor at Concordia University. Lectures also too at University of California at Irvine, specializing in contractual law and risk management. This is her second appearance on our program. And Virginia, again, I just want to extend a thanks.
 
I really do appreciate having you join us with just a slice of your time to explain these really important ideas that you have for us about how to better manage risks involved with contractors and subcontractors, and they really are so many moving parts we know within the law today. It would be nice if we could perhaps have a better understanding of what is required and what the contractors themselves have to be mindful of. Let's start from the point of view of the prime contractor, and this is the company that we would hire initially, but let's talk a little bit about that and the important lessons we need to learn for the prime contractor from their standpoint.
 
Virginia: Of course. It's always great to see the perspective from the different stakeholders involved. That then allows you to be much more educated in the decisions that you will have to make. And it will also open channels of communication that otherwise may not be so clear. So understanding this perspective from the other stakeholders involved are very important. With regard to the prime contractors, really sort of a midpoint is from their perspective, and publicly for some of them it may not even be so clear, but what they want to see is they do not want to allow the subcontractors to start work until the sub produces some sort of proof of compliance. 
 
Review of documents -- it could include certifications establishing, successful completion of the background checks, the drug screenings, whatever is required by the regulation and whatever the industry and the theme of the contract involves. It could also include certificates establishing completion of all required training as well as certificates of insurance establishing compliance with the subcontract requirements, and that those certificates of insurance are current, and for some reason people overlook the fact that they need to be current.
 
It's also the acceptance certificates for completion of transition milestones and other projects requiring those deliverables operating level agreements to confirm that they are complete and that the subcontractors are in compliance. Here's a big one, communication. Consistent communication with the prime account team members as well as the subcontractor to ensure the subcontractor is aware of any new or changed policies or requirements.
 
Another important point of communication is communication with contract managers responsible for administrating the prime contract to ensure there's alignment of the new work orders and subcontract work orders. It's a lot of moving parts as you said before to keep track of.
 
And just managing the contract compliance responsibly and with consistency requires an actual protocol for handling the incoming demands and the requirements. So it really comes down to how well do you know with whom you're entering the contract with, with whom you're going to be dealing with. And it’s very important question to have answered well, otherwise you could be in for not the greatest surprises.
 
 
Jeff: That's true. I don't know that there are too many offices today, or too many companies today that have someone on standby, on staff who are truly experts in this area of risk management and contractual law, and working with contractors prime and sub that are just standing by waiting for a workload.
 
So I'm reasonably certain that there are individuals out there that one could probably contract with to manage these projects and bring them on perhaps on a short-term or temporary basis to kind of fulfill some of these needs when companies just want to do their business. They've got business to do and their own business to conduct, and the operations as usual without having to go through the sea of work required just to stay on top of everything. 
 
We've talked about the prime contractor. Let's get into the heads and the eyeballs of the subcontractor. Because let's face it, these folks that the contractor hires are brought on to do really in some cases, the lion share of the work that is going to be performed.
 
Virginia: Certainly. And so when I spoke a moment ago about contractual flowdowns, so essentially just to recap. To flowdown a contractual clause or code requirement essentially is to impose it on your third party. So your subcontractors, your suppliers, it's down the contracting chain. And typically it's done by requiring each link in the chain to incorporate identical or equivalent clauses within its contract within the next link down so to speak.
 
So with the sub one of the most important considerations when we're talking about from their perspective they will certainly want to request a copy of the prime contract and read it in its entirety. Also they want to assess whether the flowdown applies only to their scope of work, or is it more encompassing.
 
Also, they'll be thinking about limiting the application of the flowdown to a specific list of provisions to suit their own needs. And they're also going to want to see during also the negotiation phase drafting the flowdowns so that it applies in reciprocal manner when it's appropriate. There are certain areas where they might want to do this. 
 
Another point that subcontractors typically do not give enough attention to is they may agree to a flowdown provision but here's the point. It's not a good idea to do this because you shouldn't agree to a flowdown provision before the prime contract is finalized and available for review. That's why it's always important to request a copy of the prime contract. Also, subcontractors tend to assume certain things. So they should not assume for instance that the protections, that the prime has negotiated for itself in the prime contract will necessarily benefit it as the subcontractor. So I think the biggest lesson here is really to request a copy of the prime contract and see what it actually says, because that kind of gives you the goal posts of where you'll be going.

It's always great to see the perspective from the different stakeholders involved. That then allows you to be much more educated in the decisions that you will have to make. And it will also open channels of communication that otherwise may not be so clear.

Jeff: Virginia we have just a couple of minutes left and we could probably talk about this for another show or two because we've really just kind of scratched the surface for the purpose of this segment and closing things out today. If we could kind of put kind of a sort of ribbon on this particular discussion today. What are just a few key points you could leave with us today with respect to prime and subcontract management, and risk management associated with these.
 
Virginia: I'm going to give a few key points for further consideration for people to digest. One of them is typically we see there's a lack of awareness or understanding of the risk-related contract provisions. For instance, you have the contract provision of the right to audit. Often the right to audit contract provision limits a purchaser's audit authority any issues related to pricing, and can even limit the right to audit a supplier's production processes.
 
So the problem is if the purchasing company's management is not clear on such limitations, that management may unwittingly agree to deprive itself of the valuable opportunity for the right to audit. Other examples of a lack of awareness or understanding with regard to risk-related contract provisions include service level agreements, volume rebates, and surcharge provisions.
 
It really all goes back to understanding what the contract demands of each stakeholder. We also have to really encourage people to change the mentality. Compliance should no longer be viewed strictly as a cause of speed bump to getting work done. It should be included as the business school as something we need to invest in because without the contract compliance, without understanding how to achieve contract risk management, you will be unable to fully achieve the project successfully.
 
So in all of this, it could include cataloging standard acceptable and unacceptable provisions, as well as triggers for escalated review such as indemnity clauses. There's also prioritization for the referral of issues to subject matter experts as we discussed earlier. 
 
Critical to all of this is clarity, and also what each stakeholder has in his or her authority to do and what is his or her responsibility, and to work altogether toward the ultimate goal of completing the project successfully.
 
 
Jeff: And safely by the way Virginia. And I really do appreciate you to taking the time to join us. We enjoyed having you once again on the program. And let's make plans to get together again because this is obviously a very important subject and I know that you have some other things that you'd like to share with us. So Virginia Suveiu, again, thank you for joining us today.
 
Virginia: Thank you very much for having me.

So it really comes down to how well do you know with whom you're entering the contract with, with whom you're going to be dealing with. And it's very important question to have answered well, otherwise you could be in for not the greatest surprises.

Jeff: Virginia Suveiu, attorney-at-law, specializing in risk management and contractual law has been my guest. I hope you enjoyed it. Tell a friend about Deal Talk if you would. In addition to morganandwestfield.com you can find us on iTunes, Stitcher, and Libsyn. The nice thing about morganandwestfield.com is that you can find the entire transcript right there, something you can refer to over and over again, and read as you listen to the show to grasp important key details on each topic that you hear.
 
“Deal Talk” has been brought to you Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thanks again for listening. We'll talk to you again soon.
 
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