Contractors take great care to make certain that their subcontractors have the necessary skills to perform their craft. Unfortunately, many contractors are less informed about best practices for the business relationship with their subcontractors. Without taking as much care to ensure a solid business and legal relationship, contractors put their customers, their business, and themselves at great risk of failure. This article reviews the financial, insurance, entity, and contractual guidelines contractors need to consider.
Financial
When margins are tight and the opportunity to raise prices is limited, managing the cost of subcontracted labor is the only way to remain profitable. Managing subcontracted labor cost is handled the same as your other costs – know your ratios.
Begin with your 2010 financial reports, specifically the Profit and Loss Statement. Determine the total amount spent last year on all subcontractors. Divide that number by the total amount that customers were invoiced, last year’s total revenue. The result is the subcontracted labor cost ratio. For example, if you spent $500,000 on subcontractors last year and billed customers a total of $1,000,000, then your subcontracted labor cost ratio is 50%.
By comparing the ratios for the past several years, you can determine whether your cost of subcontracted labor has been increasing, decreasing, or staying the same over that period of time. This sort of trend analysis is helpful when negotiating prices with your subs going into the new year and making the sort of decisions that will help improve your 2011 financial performance. If you know what the market will bear for a particular project, such as an insurance-paid roof replacement, you can determine the maximum you can afford to pay for labor.
Insurance
Contractors should look for ways to shift project risk to others where ever possible. The easiest way to do this is to make certain your subcontractors are fully insured.
Most insurers want contractors to require the same or greater coverage limits from their subcontractors as the contractor carries on its own policies. The contractor should insist on a certificate of insurance listing the contractor by name as an additional insured on the policy. The contractor’s insurance agent should review the certificate for the proper form and coverage that maximizes the contractor’s protection.
Unless all of the employees of the subcontractor own at least a 25% share of the business, a workers’ compensation policy is required. It is strongly advised that, even where the sub isn’t required to carry a policy, that contractors require proof of a workers’ compensation policy from every subcontractor before allowing them on a job site.
Entity
Since January 1, 2009, Minnesota law requires individuals (not corporations, LLCs or partnerships) who work as independent contractors in the building construction industry to obtain from the Minnesota Department of Labor and Industry an Independent Contractor Exemption Certificate (ICEC). For purposes of the state’s workers compensation, unemployment insurance, wage and hour, and occupational safety and health laws, individuals doing building construction work without an ICEC will be employees of the contractor for whom they are working.
The best way for a general contractor to avoid their subcontractors becoming employees is to require each subcontractor to provide an original Certificate of Good Standing from the Minnesota Secretary of State or an ICEC from the Department of Labor. Don’t assume that just because the subcontractor uses “Inc.” or “LLC” in its business name that the sub is an entity. Get a copy of the certification every year.
Subcontractor Agreement
Best practices are to obtain a signed Subcontractor Agreement, well drafted by an attorney experienced in construction law, from every sub before work begins. The agreement should include provisions for pricing, insurance requirements, and entity status.
Minnesota’s statutory warranty only binds the general contractor to warranty obligations with the homeowner. The subcontractor has no direct warranty obligations. The subcontractor agreement should create the same warranty obligation between the subcontractor and the general as the general has with the customer.
The subcontractor agreement should also include an indemnification provision, a provision requiring that all safety laws are followed, and a tobacco, drug, and alcohol provision. Because subcontractors are entities, a personal guaranty signed by the owners of the subcontracting company should be a part of the agreement.
Conclusion
The relationship between general and sub is more complicated today than ever. Margins in construction are tight so keeping your subcontracting costs under control is vital. Shifting risk to your subcontractors is key to controlling costs and proper insurance coverage contributes to that goal. Verifying the entity status of subs can ensure that the contractor won’t incur unexpected employment costs. And a well drafted subcontractor agreement helps both parties know what ‘the rules of the game’ are for the relationship.
Use care in managing the business and legal relationships with your subcontractors and make 2011 your best season ever.
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© 2011 Alden Pearson. P.A. All rights reserved.
