For the past few years, subcontractors have been experiencing the burden of a serious backlog, shortages in labor and increased costs. These factors create strong pressures on subcontractors and make them more vulnerable to default and other risks.

For general contractors, subcontractor risk is among the central challenges and difficulties that need to be faced and managed. Such risk needs to be assessed and proper strategies need to be in place to deal with it when it arises. From bonds for subcontractors to extensive financial and performance reviews, general contractors have plenty of options how to address possible risks during the construction process.

What risks are subcontractors facing?

There are a few major categories of risks faced by all subcontractors, regardless of their field. These are:

• operational risks, which include risks around safety and accidents, quality assurance, productivity, labor and supply chains;
• contract and legal risks concerning indemnity, payment conditions, site conditions, disputes and more;
• financial risks such as credit, payment, cash flow and insurance;
• political/regulatory risks, such as employment, lien and contract law risks, as well as regulatory and administrative law risks; and
• environmental risks, which include endemic environmental risks, risks of spills, leaks or discharges and airborne discharges.

All of the above risks pose a danger to the operations of a subcontractor and their ability to execute a contract as agreed with the general contractor. This in turn may spell trouble for the general contractor and the ability to deliver to the project owner. To avoid delays or default on a project, general contractors need to plan for subcontractor risk and put in place mechanisms that will help them cope with such situations.

Five Strategies to Manage Subcontractor Risk

1. Subcontractor Prequalification by Surety

One of the safest mechanisms of reducing subcontractor risk is to make use of a surety company's prequalification process. Sureties often assist general contractors in qualifying a subcontractor by carefully assessing them on the basis of their underwriting criteria. These criteria are applied to determine whether a contract bond can be extended to the subcontractor.

The criteria applied by the surety in determining a subcontractor's capacity in executing the contract include financial strength, credit history, past project experience and records, work and progress on other current projects, equipment, the size of operations and more.

Based on all of these, a surety company decides whether to extend a surety bond to the subcontractor. Given the implications of surety bond claims on a contract bond, sureties' assessment of subcontractor risk are one of the most reliable ways of determining the reliability or stability of a subcontractor.

2. Introducing Proper Contractual Terms and Conditions

Fuzzy contractual language is among the biggest causes of claims against prime contractors. Often issues caused by a subcontractor end up being the responsibility of the prime contractor due to a lack of "flow-down" provisions in the contract.

To mitigate such risks, prime contractors need to require subcontractors to accept the same type of responsibilities and obligations toward the project owner when it comes to their work, as are assumed by the prime contractor.

Contractors can also include conditions that require subcontractors to indemnify them and the project owner for failures to perform to the same extent that the prime contractor is responsible towards the subcontractor. This institutes greater reciprocity and helps keep subcontractors accountable in instances of default.

Moreover, including both contingency clauses as well as dispute resolution clauses are two important additions to a strong and secure contract.

3. Request a QA/QC Plan, When Necessary

If a prime contractor is not supervising the work of the subcontractor, instituting a quality assurance and/or quality control plan can be a very useful thing to do. Quality assurance plans require the subcontractor to detail the procedures that they will follow in assuring the quality of their performance.

Based on these plans, contractors should develop the mechanisms to perform checks and inspections of the work of the subcontractor during and after the performance of their tasks. Such controls help avoid the need for rework at a future time as well as the arising of claims due to defects.

4. Require Strong Safety Practices

An additional source of risks for subcontractors is the lack of a proper health and safety plan. Not adhering to OSHA's safety standards and practices can lead to a jobsite being shut down and delaying a project significantly.

To avoid this, prime contractors should require subcontractors to demonstrate a detailed safety plan, along with all the processes and practices that are put in place to enforce it. Prime contractors should also check their subcontractor's Experience Modification Rate to get a good sense of the quality of their safety practices.

5. Minimum Insurance Requirements

To avoid being held accountable and responsible for insurance claims that rightfully apply to subcontractors, prime contractors need to require their subs to have all necessary insurance in place.

This includes workers' compensation, general liability insurance and automobile liability insurance and possibly also umbrella insurance and professional liability, depending on the project. Requiring that sub-trade contractors are also properly insured is another level of security that can help avoid defaults and delays.