As a custom home builder in the Reno-Lake Tahoe market for almost 20 years, I’ve encountered the evil side of the custom home empire. Disguised as clients who wanted to sue me for everything, I had to avoid final payments on their million-dollar custom homes. The result was a true understanding of the legalities and real risks of custom home building during a long four-year legal battle. The myths and misperceptions I was operating under as a quality-conscious, award-winning design/builder required me to turn adversity into opportunity as a matter of professional and personal survival.
I worked for many years using fairly conventional contract formats, which were either lump-sum agreements with allowances or a cost-plus-a-fee agreement. Typically I purchased materials, ran carpentry crews and subcontracted for the work. It functioned well until the final $100,000 was held back by a client with questionable ethics and morals. To my dismay, I learned I had no corporate veil protections due to license and trade account personal guarantees. I had not only exposed my business, but inadvertently my family, to the risks of being sued. I now operate only as a construction manager/owner’s agent.
My local lenders, attorneys, insurance specialists, trade partners and CPA have embraced my new contracting format. But the biggest hurdle was investigating the insurance coverages and the potential problems in that arena. To my surprise, the insurance issues became the single best reason to work using this format.
If interested in following my path, I’ve provided the concept, which you might have to tweak for your municipality. But first, get a local, knowledgeable construction attorney to review your plan for compliances and statutory requirements.
How it Works
The client is an owner-builder with the choice of following your advice or rejecting it. He hires you for your professional services, advice and experience, and local knowledge of the trades, suppliers and market. You as the CM/OA do the same things you would with a typical construction contract, except you get paid for everything, because the agreement is fee-based or a specific cost is identified as reimbursable. You can invoice for every meeting, phone call or predetermined costs for certain services. Your accuracies and confidences in how you calculate and expense overhead costs will be your guide.
I have my clients open a project bank account and authorize me as a signer to the account, similar in nature to an attorney’s trust account. As agreed, I provide a payables list and cash requirements for their approval, they wire the funds into the account, and I pay the bills. They get the bank statements for control. I verify the deposit was made and then issue checks. I provide detailed job-cost accounting as the job progresses and I even reconcile the bank account for them.
If they go sideways, I terminate my CM/OA agreement with a 10-day notice and go to small claims court, representing myself, for my fees if any payables remain due to me. The relationship is done and over without a drawn-out legal battle. I then contact the suppliers and subcontractors as a professional and suggest they stop work and lien the project to get paid, since I am no longer associated with the project as an agent of the owner. Any specific credit accounts for lumber, cabinets, appliances, etc., are opened for the owner, with the owner’s personal payment guarantees, not mine.
I draft and negotiate all subcontracts, purchase orders and get insurance certificates and payment/lien releases from all the subcontractors and vendors as the owner’s agent. Since the basis for the contract is either a specific fee, or a combination of fees, percentages of costs, or reimbursable expenses, everything is open-book with the client.
General Liability/Comprehensive Personal Liability. The owner purchases the policy with limits and coverages as desired. Because it is owner-purchased, the costs are reduced from anything on the market available to a contractor or builder. The $1 million GL and medical payments to others policy for one of my projects has a premium of $806 for a 12-month policy. The policy also names me as additional insured as the construction manager.
The general liability policy purchased by the owner also presents a real hardship for the owner to sue anyone for defects other than an individual subcontractor or vendor. No more huge class action lawsuits, with everybody’s insurance company contributing toward a bigger pot of gold for a client’s attorney.
Course of Construction/Builder’s Risk/Fire. Owner purchases the policy with the limits and coverages as desired. The $900,000 replacement value policy costs for the same project mentioned above were $1,980.00, for a 12-month policy.
Errors and Omissions/Professional Liability. I declined to purchase this type of coverage because of my cost/benefit analysis. The insurance company was going to charge me more than $5,500 for professional coverages based upon $250,000 in gross receipts for the construction management business. In addition, they insisted upon a self-insured retention of $10,000 as part of the policy. I went bare for the following reasons:
1) Any risk for explosion, collapse and settlement, which is the biggest risk as a designer or builder, would be covered under the structural engineer and truss company’s liability policy and related insurances, and from the subcontractors on the project.
2) The professional policy would not cover any alleged defects.
3) The subcontractors’ general liability policy would name the owner and me as additional insured, which covers the defect potential.
4) The professional policy would not cover any subjective or aesthetic issues, which usually stem from a client’s unrealistic expectations or becoming a victim of their own decision making, emotional or otherwise.
5) I would be responsible for defending a claim up to the first $10,000 in costs. With that kind of deductible limit, the policy costs of $5,500 and the protection of the subcontractor and owner’s policies, I chose not to exercise this option because it was expensive and did not offer much protection.
To close what remains of a potential exposure, I have the client hold me harmless and indemnify me with regard to any claims for subjective or aesthetic issues and rely on their direct contract for services with the engineer and truss manufacturer for serious structural issues. This separates the costly concerns as opposed to the width of a door reveal or an accepted tolerance for finish work and a client’s unrealistic expectation not being achieved.
The majority, if not all issues and regulatory exposures, are negated using the construction management contracting concept, which includes:
1) Payment issues are minimized and reduced to current fees only. Possession of the property resides with the owner, along with any lender trust deeds and loyalties, but conflict resolution avoids the extended time required to resolve any traditional liens or litigations. Smaller sums, small claims court and no attorney requirements increase mobility and reaction time, thus shortening the resolution period.
2) No construction defect claims from the owner to offset getting paid since they were the owner–builder. The owner can’t sue themselves for any alleged construction defects.
3) No contractors board workmanship issues or notice to correct directives, based upon the state regulatory procedures, which can validate an attempt to bring alleged construction defects against a builder.
4) The un-enforceability of the pay-when-paid clause in subcontract agreements is no longer an issue, since the owner is directly contracting with the subcontractor.
5) No problem with credit accounts or trade accounts since each required personal guarantee is from the owner, not me.
6) All notices and disclosure requirements for companies and personnel performing work on the project are negated since the owner is contracting with them directly.
7) Unemployment and workers’ compensation contribution payment guarantees are the responsibility of the owner. In Nevada, general contractors and builders are responsible for the contributions of their subcontractors unless they get a release that the contributions have been made from the insurance company covering the worker’s compensation and the unemployment department.
8) Any direct labor requirements are handled through a separate company and invoiced to the owner just like a subcontractor. This covers specific functions and narrows down the costs of insurance coverages for workers’ compensation and general liability since it would be for a minimal amount of casual labor. Labor rates, equipment rentals, etc., are agreed upon and not open for negotiation after construction starts. Hourly wages, costs and markup are removed from the items a client can dispute simply because they can relate to how much someone makes as an hourly wage.
9) The construction management contract format removes any contractors board/license limitations for a contract dollar amount for that licensee. Instead of a license limit for the value of the entire project, only a license limit that covers fees and reimbursable expenses is required.
10) Mold and other disclosure issues or limitation of liability explanations become much less of a risk to the construction manager as opposed to a contractor or builder.
One of the reasons I enjoy custom home building so much is due to my new approach and mind- set. Now that I have removed the risks associated with the potential liabilities resulting from a client’s irrational decisions or personal agenda, I am having fun once again. We are all striving to see a client’s dream become reality, while running a profitable business with minimal risk.