Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice 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.
At some point in time many growing businesses find the need for more space in order to grow their business, and that could mean hiring a building or construction contractor to expand or make improvements to your current facilities, or maybe even build a new location. Unfortunately, working with contractors can sometimes pose serious problems including major financial and legal risks, but we're here to help you avoid some of the common pitfalls with today's conversation. We're going to be getting the insightful feedback from our guest expert Ms. Marina Manoukian. She's senior counsel at ADLI Law Group PC in Los Angeles where her practice primarily focuses on civil litigation, business, construction, and even family law. Marina Manoukian welcome to the program, good to have you.
Marina: Thank you Jeff, I'm happy to be here.
Jeff: We appreciate you taking the time and sharing your expertise in a very, very important topic. Today we're talking about ways to save potentially money and some real headaches that can be associated with construction projects where the need is to go out and you need to find a contractor. And a company has to make sure that the contractor is licensed. We've all heard that, but what I'm kind of wondering is we've heard this drum beat for so many years. Is this really a serious problem among businesses today, Marina, from where you sit? Is this still something that is a critical problem in something that many companies end up making a poor decision about?
Marina: Absolutely Jeff, and I'm so glad to be talking about this on your show because I'm often am asked to come into a situation after it's already gone wrong. And what I would like to talk about today is what to do to have things go smoothly. The first thing that companies should be doing is to search on the State's website to see if the contractor is licensed and that's the cslb.ca.gov site and to check to see if the license is active, if there are proper insurances in place. Because on the CSLB website you could actually check to see if they have the necessary bond. You could see if there are personnel that have been disassociated with the company. Those are sometimes red flags to look for. And if you can see if they've had any history of suspensions. These are all red flags. So when hiring a contractor you want to make sure that the contractor is licensed not just because they tell you they are but you've checked on it.
Jeff: I think that's really important because every contractor it seems, they go to great lengths to make sure that you understand that they're licensed or should be because they put that information on their business card. They may put it on an estimate, it'll be on their trucks or what have you. But that doesn't necessarily mean that the license is current, active, or hasn't been suspended for some reason. And so you mention again and here's the website. It's worth repeating. It's www.cslb.ca.gov. That's for those companies that are operating and doing business in the state of California. If you're listening from another state across the country you can check with your own contractor's state licensing board. I'm sure that you’ll have one in your state as well. Or contact an attorney to help you with that. Let me ask you this Marina, can you explain to me what a bond is? A lot of people may not know exactly what it means to be bonded as a contractor? What does that mean?
Marina: Sure. That's a very limited insurance policy. Currently the minimum that they ask for is $12,500. To be clear, a lot of property owners think that, "My contractor is insured, so if something goes wrong I'm covered." That's not necessarily true. There is no such thing as construction insurance that covers the actual work if the work has been done defectively. The bonds that the CSLB requires is limited in certain situations like if the contractor abandons the project or if there's any fraud in the contracting or the deal, that's when that $12,500 comes in, and you don't even often get the whole amount because the cost of an attorney representing the contractor's bond is deducted from this amount. It's not that much of a protection but it is there. And sometimes when a contractor abandons a project you can seek the bond and the bond can pay you whatever amount that is calculated at that point.
But there are insurance policies that do cover some problems during construction. When I say that the work itself isn't covered, that's correct because there are no insurances that would cover the actual defective work. But to give you an example they would cover personal injury or property damage caused by the contractor's work. To give you an example of a situation like this: if a contractor's doing work and there's a hole in the ground and that hole is not covered, and somebody walks, trips, and falls into that hole and gets injured, that insurance policy would cover that injury. On the construction side let's say that it's a roofing contractor and the roofing material, the waterproofing has not been done properly and water gets into the house or building and damages the ceiling and dry wall, it damages the hardwood floors, whatever else. Everything other than the roof itself would be covered by that insurance. But re-doing the roof itself which is the defective work would not be covered by insurance.
These are all red flags. So when hiring a contractor you want to make sure that the contractor is licensed not just because they tell you they are but you've checked on it.
Jeff: Marina, is it common for contractors to provide their own company guarantees for quality workmanship so that if in case something were to go wrong down the line that, that sort of damage or that sort of faulty construction would in fact be covered by the contractor down the line?
Marina: I think, Jeff, you raise a good point that we do need to talk about what the agreement is between property owner and contractor.
Jeff: Very good. And that's a pretty long conversation I know. So probably a great segue into it then Marina, let's talk about that a little bit. What should that agreement include?
Marina: First of all there should be a written agreement. If you're doing a big enough project these agreements are often drafted by the contractors or their lawyers so you can imagine that they would be one-sided. You would want to as a property owner have your own lawyer look at these written contracts. But the things to look out for in those written contracts are what you were talking about which are some warranties. There are warranties for new construction that contractors can give. Those warranties are typically about for one year. But in the contract you can talk about the budget, you can talk about the schedule, because these are things that the contractors require to put in the contract. And you want to have the plans and specifications ready when you do enter into a contract because that is what considers your scope of work.
If you bring in a contractor and say, "Listen, I want to do an expansion on a building. I want to add 5,000 square feet to this building over this parking area. And the contractor say, "Oh sure, I can do that for $500,000." That's not necessarily the deal that you want to get into. What you want to do is you want to have an architect, structural engineer, mechanical engineer, you want to have plans that have gone through plan check, in whatever city you're at gotten approval then gotten permits. And then you have the approved set of plans and specifications that you give to the contractor and say, "How much to build this?" That forms the basis of your scope of work. Once the contract has a scope of work and pricing for it then your contractor will have a hard time increasing that price later on, because if the scope doesn't change he's supposed to finish the project for the price that he gave. Sometimes the scope does change because the owner changes their mind or some unforeseen conditions arise and that's very, very common in construction that there are change orders. But when you are entering into a contract you want to have your approved set of plans and specifications, and you want the contractor to tell you, "This is the line item budget to do this construction." The line item budget should have a contingency in there because in everything in life you think that you're going to be done with a certain price and it always goes up. You want to have a little cushion.
So you have the contingency in there, and then you ask the contractor also to give you a schedule. A contractor calls this a critical path schedule where they show you how each trade will start and finish their work, and it makes the contractors also plan ahead. So then you know when you're going to finish and you can hold the contractor to that schedule and say, "Where are we with the schedule?" To have a good set of contract and construction plan in the beginning is one of the best ways to avoid problems later.
What you want to do is you want to have an architect, structural engineer, mechanical engineer, you want to have plans that have gone through plan check, in whatever city you're at gotten approval then gotten permits.
Jeff: When you hear stories often times, Marina, about claims by subcontractors and suppliers that they don't get paid on a timely basis. That can hold up a project also. How can a business owner protect him or herself against claims like these that create serious delays and needless disputes that nobody wants to be a part of?
Marina: This is a serious problem because when material suppliers and subcontractors don't get paid they have the right to put mechanic's liens on the property. And the property owner will be scratching his head thinking, "I paid the general contractor. How did I end up with this lien on my property?" There are ways to avoid this and there's different paths to take to get to a point where you're feeling secure you're not going to get these claims. One option is on larger projects, to use a fund control company because sometimes these constructions for business properties require a construction loan from a bank and oftentimes the bank will require you to use a fund control company. What a fund control company does is that they take the budget that you receive from your contracts, the line item budget.
And there's also something called the schedule of values. The schedule of values is the amount for each trade. Let's say a trade would be plumbing, electrical, framing, things like that. They take the schedule of values and they are basically holding the purse strings, they're holding the money. Whenever the contractor starts the project and they get to a certain point like in 30 days they draft what's called the voucher for payment. And in that voucher it's an application to the fund control companies saying in these trades we've completed 15 percent, 20 percent, whatever they think that their percentage of completion is, and then they send it to the fund control company. Now, what the fund control company is supposed to do, and I say supposed to because sometimes this doesn't happen and I've seen it afterwards when I have to get involved. But what they're supposed to do is send somebody out there to their project who understands the plans, who understands the schedule of values, who can review the actual work and make a determination whether the percentage that the contractor says they've completed they've actually completed. Once that's done payment is issued. So in that way you're not pre-paying or overpaying the contractor when they haven't done their work. And the fund control company can make sure that material suppliers and subcontractors are also paid and so they don't have any complaints. That does take some sort of an expense to go through this fund control company but oftentimes the construction lender will require this.
Another way is to ask the contractor to buy what's called a payment and performance bond. This is an insurance policy that basically secures performance and payment. And when I say performance what I mean is that sometimes contractor find that they cannot continue on a project. It's called an economic breach because what they do is they commit to a certain number to finish the project and then they realize that, "I can't do it within this budget, I'm going to lose money." So they decide to abandon a project. This happens more often than people can imagine. Once that happens, if there is a payment and performance bond in place the insurance company will pay for completing the project. The owner would have to pay whatever their contract price is. But if they end up having to pay more than their contract price the insurance policy pays for the excess. The payment part of that bond covers payments to subcontractors. If the general contractor does not pay the subcontractors or the material suppliers then this insurance policy will pay these subs and material suppliers so that the owner doesn't have to pay twice or risk having a mechanic's lien. These are two methods for larger projects.
The cheapest method to make sure that your material suppliers and subcontractors don't have claims against you for non-payment even though you've paid the general contractor is to write joint checks. In order to do that you'll have to ask your general contractor to give you everybody's names and their invoices so that you know who's working on your project, who's giving you materials to build the project with, and how much they're charging, so that when you want to pay for these subcontractors and material suppliers, you're writing a joint check with the general contractor and them so that neither one can cash it without the other's approval, that's kind of a way to protect yourself from the general contractor not paying the subcontractors. With these three methods you can make sure nothing is full-proof but you can do a lot to make sure that there's not material supplier or subcontractor who hasn't been paid who will come after the owner and record a mechanic's lien on their property.
Jeff: Outstanding words of advice and there were three methods we talked about there and I'm going to give Marina's contact information at the end of the program. So that if you have any questions about these particular methods to help ensure that these guys get paid on the project and it keeps moving forward. Marina will be able to provide with that information and answer any other questions that you might have, I'm sure. I'm Jeff Allen and I'll be back with business and construction attorney Marina Manoukian when Deal Talk continues in just a moment.
The cheapest method to make sure that your material suppliers and subcontractors don't have claims against you for non-payment even though you've paid the general contractor is to write joint checks.
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Jeff: Welcome back to Deal Talk where we are becoming the Internet's go-to resource to help business owners understand what it takes to sell their company successfully. You can find a wealth of resources along with all Deal Talk episodes and their transcripts simply by visiting morganandwestfield.com. I'm Jeff Allen with my guest Marina Manoukian, senior counsel specializing in litigation, business, and construction law at ADLI Law Group with offices in the LA area.
We're continuing our discussion now about how you as a business owner can avoid the stress, unnecessary delays, legal and financial risks that can sometimes be associated with contractors on construction projects. Marina, to kind of continue the conversation now, who do I talk with? If I'm a business owner and I know that I'm working with a general and I need to make sure that I communicate and keep the communication open with them at all times, can I talk with the general contractor? Can I talk with the subs? If a guy comes in, in a restroom we have in our lobby. I’m not really happy with the way that they've laid the tile in there. Can I talk to the subcontractor? Who should I be interfacing with?
Marina: It's always best to keep the lines of communication open. The general contractor is usually the point of contact for the owner. But again, on larger projects and may be in the owner's best interest to hire its own project manager so that there is an owner representative who is knowledgeable in construction to deal with the general contractor, and the subcontractors, and the material suppliers.
Jeff: Typically, is this something that we see with the larger projects, with larger companies on bigger projects?
Marina: Yes, definitely, because the owners are either too busy, and most of the time property owners are not that knowledgeable in construction unless they've done it many times. To have your own project manager who's watching out only for the interest of the owner is extremely beneficial to stave off any litigation later. With keeping up with the schedule somebody has to be on top of a general contractor because the schedule is one of the biggest areas of contention when the construction doesn't go as planned. And you want to make sure that you're happy with whatever they're doing because, for example, if they've laid the tile and on top of that they're going to be putting cabinets. If you're not happy with the tile you don't want them to be going onto the cabinets. You want to keep the lines of communication open with the general contractor or get your own project manager.
To have your own project manager who's watching out only for the interest of the owner is extremely beneficial to stave off any litigation later. With keeping up with the schedule somebody has to be on top of a general contractor because the schedule is one of the biggest areas of contention when the construction doesn't go as planned.
Jeff: Let's say we move down the line and we've had a few bumps in the road but things for the most part have gone pretty nicely, and we're just about to the point when we are going to occupy our new building. It's passed inspection. But once we get beyond that I guess I'm a little bit concerned as the business owner that maybe things may not necessarily be quite right and I'm worried about defects and all of a sudden I've got my business partner Bob, he's upstairs in the break room at our new building. He has a doughnut and ends up falling through the floor or something like that, I don't know. But let's just say ... It's a funny visual we can put in people's heads at the moment. But what if something happens down the line and it passes inspection, things seem to be great, and all of a sudden we have this happen.
Marina: I have to warn people, because every construction does have to go through an inspection process with that city. They do inspection of the rough meaning the electrical or plumbing works that hasn't been covered by dry wall. They look at the framing that hasn't been covered. They pass inspection and then you go through the next phase and they come and do an inspection of the finished product. And most people think, well, it passed inspection. This project will not have any defects. Well, Jeff, if that was the case then I wouldn't have a job defending contractors on defect claims or representing owners to go after defect claims. Defect claims exist regardless of whether properties have passed through inspection because these city inspectors they're looking for certain code compliance but not necessarily defects that might be just industry standard defects. You haven't done this. You haven't water-proofed properly so now water is seeping through the shower to the bottom floor, things like that.
First, let's go back to when the project it’s almost complete. At that point when it's almost complete it's best to never pay the last payment to the contractor unless you've done a walkthrough and are happy with the product that you're getting. Because upon the last walkthrough you can go through a punch list, meaning a list of little things that you want fixed before the contractor completely leaves the project. Because to be clear, if you paid their last payment that contractor's gone. I'm not trying to discourage any contractors but it just makes sense. They've been paid, they think they're done, they're not going to come back too many times. Some of them are very honorable and they do come back and complete punch list items but you want to be holding that back so that you're satisfied before giving it to them. So you go through the whole project and whatever you have a problem with you write a list meaning there aren't enough electrical outlets here, this door opens the wrong direction, whatever you see. This window doesn't seem right, it's not level. You make a list, you give it to the contractor, and you make sure that they do all of that before you release the last money. And one thing to go back to as far as making sure that contractors don't have claims against the owner afterwards.
Every time the money is released to the general contractor, subcontractor, or material supplier there should be a form completed by them called a lien release. It's a conditional or unconditional release upon partial or final payment. These are forms that can be easily found on the Internet. If anybody calls me I'll be happy to send it to them. You have the contractor sign for the amount of money that they have received. So you have this cushion where they cannot come after you for that money. But at the end when they've gone through the punch list item, corrected everything, then you give them the final payment, and you get an unconditional release upon final payment. So that takes care of it. They cannot come after you after that.
Later on, if you do discover defects, as I said that there's the warranties that you can call on so don't sit on them. Certainly don't sit on the complaints over a year because when you call they'll say, "I'm sorry, your warranty is up." Don't sit on them, call them. There is a difference between a warranty and whether you've lost your legal rights to make a claim. The warranty is whatever the contractor decides to give you, meaning 12 months, maybe 36 months on certain components. Your deadline to file a lawsuit is called the statute of limitations. And for defects that are physical and it's based on the contractor breaching their contract because they didn't give you work without defects because it's obvious that you see. It's a four year deadline to file. But most people say, "No, I have 10 years." So the 10 year deadline to file is only for latent defects where latent means not obvious, hidden. So something behind the wall, something in the foundation, something that when you're sitting or walking through the building you cannot see. Those are the types of defects that you're allowed to bring in within the 10 year deadline.
So these are things you'll have to deal with afterwards, but the best way to avoid it is to have your own walkthrough, make sure everything is the way that you wanted. You won't be able to catch any latent defects, hidden defects, but at least you'll catch the ones that are visible and hopefully move on and have a defect-free project.
Jeff: Please be advised that these are California statutes of limitations that we've been talking about here associated with those warranties and about making sure that you have the time to go in and file a claim in the state court against the contractor, again in California. But in your area, the statute of limitations may be different so please check with an attorney in your state or in your city about the laws that apply to you where you live and where you do business. I think that's really important to mention.
Marina, this has really been a fantastic conversation and I think we could probably extend this longer if we wanted to. And I know that there are more items involving business and construction law that we could probably talk about another time. So we would like to have you back on again. However, for this segment we have run out of time. Just real quickly, if you could leave us with some final thoughts about some things that you just think that people absolutely need to remember when they're considering a new construction project for their business what would those things be?
Marina: To be honest, Jeff, not to promote my work, if they can get an attorney involved in the beginning they can actually avoid litigation at the end. That would be my advice, for an attorney to be in on it in the contract drafting and approval, and also for advice throughout to avoid the litigation part it.
I'm not trying to discourage any contractors but it just makes sense. They've been paid, they think they're done, they're not going to come back too many times. Some of them are very honorable and they do come back and complete punch list items but you want to be holding that back so that you're satisfied before giving it to them.
Jeff: Marina, I know that no doubt there are a number of listeners to Deal Talk in Southern California that would probably like to speak with you perhaps if they've got a project that they are looking at and they would like to get your counsel, seek your advice, how can they reach you?
Marina: Absolutely. The firm name is ADLI Law Group. My telephone number is 213-623-6546 and the website is adlilaw.com. In either way they could reach out to us and I would be happy to help anybody.
Jeff: Marina Manoukian, I thank you so much. I enjoyed the dialogue and hopefully we can have you back on again to continue our conversation and maybe go to some other areas or some other topics with you as well. Thank you again so much.
Marina: Thank you for having me.
Jeff: Marina Manoukian, senior counselor at ADLI Law Group PC has been my guest.
We hope you enjoyed the discussion and to listen to more Deal Talk including this episode again all you have to do is visit the morganandwestfield.com website. Click on the podcast link at the top of the site. And if you consult or work with business owners prior to, during, or after the transaction process and you'd like to join us a future guest to share your expertise, contact me directly at 888-693-7834 extension 190, or you can email me at email@example.com. Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Find out how Morgan & Westfield can help you at morganandwestfield.com. For everyone at Deal Talk, I'm Jeff Allen. Thanks again for listening, we'll talk again soon.
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