Growing programs, expanding service offerings or making substantial repairs to existing facilities make construction projects an inevitable part of the not-for-profit operating environment. Although a necessary part of operating, not-for-profits should approach each construction arrangement cautiously. Undertaking large projects comes with a fair amount of risk. Failing to adequately understand where your organization may be at risk can lead to overspending and, in certain cases, legal disputes. For not-for-profit organizations, maintaining project costs is essential. Knowing the five major risk areas in construction contracts can help you manage your ongoing or upcoming projects to ensure you are not overpaying.
1. Contract Language
The biggest risk to any construction project owner lies in the contract itself. Too often construction contracts are muddied with unclear language that makes it difficult to determine reimbursable project costs. When a contract is drafted using clear and transparent language, it allows every party to know exactly what the scope of work entails, which costs fall within that scope of work and which costs do not. Clauses and provisions should be written so that someone unfamiliar with the project, such as an arbitrator or judge, can easily understand the costs to be reimbursed by the owner to the contractor on the project. Clear, concise contract language can also mitigate an owner’s risk related to potential project cost issues.
2. Project Budgets
For cost reimbursable guaranteed maximum price (GMP) contracts, contractors are compensated for actual costs incurred, in addition to a fee, up to a guaranteed maximum amount. Because the contractor will be compensated for actual cost as defined by the contract agreement, detailed project budgets are essential to ensure that the GMP budget is not artificially inflated. On cost reimbursable contracts, owners need to carefully review budget line items to confirm that the amounts represent a contractor’s actual cost and comply with the provisions of the respective contract agreement. Removing unnecessary or overstated budget line items can save owners a significant amount of money on their construction projects before construction even begins. One university was able to identify a budget overstatement of $919,000 by its contractor from a CBIZ budget review.
3. Labor Rates
Each executed contract should detail the reimbursable labor rate costs associated with your contractor and subcontractors. It is important to review labor rates prior to starting any work to determine whether they are in accordance with the contract agreement and represent a contractor or subcontractor’s actual cost to perform the work. Contractors selected through a competitive bidding process will likely present low, lump sum contract amounts in order to win the work. However, when contractors determine the price for change order work, it is not based on a competitive bid process. Pricing is often inflated as a result of overstated labor rates. Many organizations have benefited from labor rate reviews in order to guarantee they are receiving the best possible price. You can drive down labor costs on your projects by using a third-party construction auditor that has a database of national contractor labor rates and a comprehensive understanding of construction labor costs.
4. Change Orders
With any major construction project comes surprises that can increase the scope of work. Even if your organization drafted the project contract using clear language and selected a fairly priced contractor to do the job, there is still the possibility that additional work outside of the original estimate will be required. If it is necessary to deviate from the original plan, a change order will be needed. For example, if a project required additional electrical work outside of the original scope, the owner and contractor would execute a change order detailing who would perform the additional work as well as the cost of materials, equipment and labor for the new scope. For one museum client, a change order reviewed by CBIZ identified over $60,000 in cost recovery. It is important to carefully review every change order to gain an understanding of why the change is necessary and assess pricing to confirm that it is fair to all parties.
5. Insurance and Bond Costs
Many contractors’ project costs are often overstated as a result of complex self-insured insurance and bonding programs. Contractors can also inflate their insurance costs by billing for additional coverages not required by the contract agreement or by billing for limits in excess of the coverage required in the respective contract agreement. A university client recently uncovered $76,000 of performance and payment bond over-billings from conducting a construction audit. It is important that every owner carefully review the insurance coverage and costs related to their project to guarantee adequate insurance coverage, while also mitigating financial risk to potential insurance or bond over-billings.
Understanding the major risk areas not-for-profits face prior to beginning a construction project will help you to manage that risk from project inception to completion. At a minimum, not-for-profit organizations should execute clear contracts that consider the pricing of project budgets, labor rates, changes in the work, and insurance costs so that your project can stay within budget. When each of these risk areas is taken into consideration, organizations avoid costly over-billings and potential disputes. For more information on the benefits of a construction cost review, please contact us.
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