Six Strategies for Handling Subcontractor Default

  • Editorial Team
  • Heavy Construction Equipment
  • 10 October 2023

It can be a real headache for the general contractors to have to deal with a defaulting subcontractor. A project can suffer a lot from a nonperforming subcontractor or one that is not adhering to the contractual commitments.

This could cause schedule delays that have an all around negative effect on other subcontractors and cost-prohibitive rework. A project can even be killed if there is a need to find a replacement for a fired subcontractor. It is a must for you to cooperate with a subcontractor to address any problems before they worsen and become too out of control.

First and foremost, you need to remember that no subcontractor ever signs a contract with the goal of not carrying out the work. Before they begin to be paid, subcontractors need to actually advance a sizeable amount of the project’s expenditures.

Despite having the resources to complete a project when it has started, the project can soon have different cash flow issues. Subcontractors frequently fall into default when they take on too much work or when a contractor on another project fails to pay them on time.

Select Your Subs Early

Make sure subcontractors are capable of executing the work, both physically and financially, before asking for pricing or bids. Examine your prequalified subcontractors to exclude those who lack experience with the project’s size and scope. Even though you frequently collaborate with a dozen prequalified electrical contractors, it is totally possible that only six of them are approved to complete this particular job. Obtain bids from those six for the project.

Be as transparent as you can and explain the situation if a subcontractor ever inquires as to why they weren’t requested to submit a bid. Your goal is to keep all of your subcontractors in good standing. You may still require them for other projects even if they are not ideal for the current one.

Look for the Signs

When problems start, subcontractors might not always be open about them. Even if they are doing their jobs and keeping to the schedule, problems can be simmering below the surface. It is important to maintain a close eye on all of your subcontractors to look for any indications that they may be struggling or in danger of defaulting.

A sudden drop In the number of workers assigned to a project, a change in manner, a delay in the delivery of goods, and nonpayment of subcontractors or suppliers on schedule are typical indications that a subcontractor is having difficulties. If you think things might be going off course, keep an eye on your subcontractors in a proactive manner.

Don’t let yourself get deceived. Regardless of whether your subcontractor is completing their work as necessary, you should discuss any of these warning signs with them as soon as you start to notice them. Waiting too long to respond to a subcontractor who may be having trouble can have a domino effect that can ruin the entire project.

Develop a Plan

You must sit down and work with the subcontractor to fix the problem, whether you find it on your own or they contact you about it on their own. After identifying the problem, you must ascertain its underlying cause.

Find out if they are experiencing issues with a subcontractor who is not really performing well or a supplier who isn’t delivering materials on time. Make sure the problem is not that you are not paying them enough or on time for the task. You need to find out if they are experiencing cash flow issues because of late payments or something like that.

Have a conversation with your subcontractor about the options available and what you can do to get them back on track. Usually, this is the simplest and most affordable option. Construction work requires the use of heavy equipment and machinery all of which are quite expensive. If cash flow issues make it impossible for the subcontractors to purchase the equipment they need, the project will automatically get delayed.

Most of the time you can help them with something as easy as adding some of your own employees to their staff or doing some of the work yourself. In order to reduce some of their financial obligations and enable them to concentrate on paying their employees and completing the project on schedule, you might need to change the subcontract to a labor-only contract.

Include everything in the Contract

Make sure your contract contains clauses describing your rights to add work, halt the subcontractor’s activities, or even cancel the agreement. Of course, failure to complete work as requested should be included, but you might also wish to mention instances like paying suppliers and subcontractors late. The agreement should also grant you the right to be compensated for any reasonable expenses you incur if you intervene.

Before you exercise your right to add additional work to their project or take other legal action in the event of a subcontractor default, you should be sure that you adhere to any and all notification requirements. In accordance with customary contracts, you must give the subcontractor written notice of the default and a timetable for remedying it.

The general contractor may step In and complete the job if the subcontractor doesn’t correct the default within the allotted period. If the subcontractor later asserts that adding to their job wasn’t necessary, failing to give written notice as required by the contract may give rise to legal problems.

The contract should also have a clause that immediately cancels the agreement in the event that the subcontractor declares bankruptcy in order to further safeguard your interests.

Protect yourself

Subcontractor bonds and subcontractor default insurance are the two most popular ways to guard against subcontractor default. There are distinctions in how they operate, who bears the risk, and which parties are protected, but both are used to manage the risk of subcontractor default.

The general contractor will submit a claim in the event of a default and is in charge of handling the default and finishing the project.  If they submit a claim, they are also accountable for paying deductibles. Since there is no guarantee of payment in the event of a default, suppliers and sub-subcontractors get the short end of the stick.

Other security strategies include increasing the retainage, obtaining a personal guarantee from the business owner, or having the sub acquire a line of credit.

Termination of the Agreement

Subcontract termination should only be done after serious consideration and as a last resort. The most expensive and time-consuming approach for handling subcontractor default is usually termination. Terminating a subcontract almost certainly means you’ll have to rebid the remaining work, which will push back your deadline and be more expensive than your other options.

Once more, the contract should specify in detail when you can terminate the subcontract. It is typically advisable to cut ties and end the contract early on in a project if there are several warning signs or if the subcontractor is having serious problems. This will prevent the problem from spreading to other parts of the project.

You are probably better off working with the subcontractor to find a solution if they’re experiencing some minor problems. The best course of action is to supplement the work rather than canceling the contract, if the subcontractor defaults on the project when it is almost finished.

In dealing with a subcontractor who defaults, you should consider how much it will affect your ability to effectively complete the project. Instead of just terminating the contract, most problems may typically be solved by simply engaging with the subcontractor.