A General Contractor’s Hidden Risk: Lower-tier Subs and Vendors
Who is this article for?
Anyone who has potential risk exposure due to lower-tier subcontractors and vendors. This includes:
- Finance Departments
- Accounting Departments
- Project Management
- Executive Leadership
In this article, we want to answer the following:
- What is a lower-tier subcontractor?
- How can lower-tier subcontractors cause risk exposure?
- How can you mitigate that risk?
The most common places to uncover hidden lower-tier subcontractors
Lower-tier subcontractors and vendors, also commonly known as second-tier subcontractors and vendors, are an additional layer of workers hired by the primary subcontractors and vendors. Think of it like this: general contractors hire subcontractors who hire lower-tier subcontractors. If you have ever been onsite for a project, it’s almost inevitable you have encountered lower-tier subcontractors or suppliers.
Examples of lower-tier subcontractors & vendors:
- Second-tier subcontractors (second-tiers)
- Sub-tier subcontractors (sub-tiers)
- Lower-tier subcontractors (lower-tiers)
- Tiered contractor
- Tiered subcontractor
- Specialty contractor
Suppliers & Vendors
- Material suppliers
- Material vendors
- Project vendor
Lower-tier subcontractors or suppliers are the go-to solution in the case of a capacity issue or for a job that requires a specific expertise. By adding this extra layer of workers to projects, it can help ensure projects meet deadlines and stay within budget.
Certain trades are more likely to involve lower-tier subcontractors due to the nature of their specialized work or the scale of projects they handle.
Trades where it is most common to find lower-tier subcontractors:
- Electrical contractors often subcontract certain aspects of their projects, such as wiring, lighting installations, or specialized electrical systems, to lower-tier subcontractors with specific expertise.
- Plumbing contractors may engage lower-tier subcontractors for tasks like underground pipe installations, specialized system installations, or fixture installations in large projects.
- HVAC contractors frequently rely on lower-tier subcontractors for tasks like ductwork installation, refrigeration system installations, and specialized HVAC system components.
- Flooring contractors may subcontract specific types of flooring installations, such as tile work, hardwood floor installation, or carpeting, to lower-tier specialists.
- Roofing contractors may subcontract certain roofing materials' installations, such as solar panels, skylights, or specialized roofing systems.
- Painting contractors may hire lower-tier subcontractors to handle particular painting techniques, such as murals or faux finishes, in large projects.
- Drywall and plastering contractors might subcontract taping and finishing work to lower-tier subcontractors with expertise in these specific areas.
- Landscaping contractors may use lower-tier subcontractors for specialized landscaping tasks like irrigation system installation, hardscaping, or tree maintenance.
- Concrete and masonry contractors might hire lower-tier subcontractors for tasks like decorative concrete work, masonry restoration, or specialized concrete finishing.
- Specialized Equipment Installation: For projects involving specialized equipment installations like elevators, escalators, or industrial machinery, lower-tier subcontractors with expertise in this area might be engaged.
Why you - as a general contractor - may not know when lower-tier subs are working on your project
There are many moving parts when running a project and as the scale of the project grows, so does the management complexity. Between internal upkeep and the management of prime subcontractors, project accountants and project coordinators are spread razor thin.
No direct relationship with lower-tier subcontractors
As the general contractor or construction manager, you prequalify your primary subcontractors. However, you might not always have the opportunity to prequalify the lower-tier subcontractors.
It is common practice for primary subcontractors to bring in their own team of lower-tier subcontractors to complete their portion of a project. It is also common for primary subcontractors to have the autonomy to make their lower-tier subcontractor selections. This means that you might not know who your subs plan to bring to the project unless it is specifically outlined in your contract with them.
Many times, when the project is kicking off, your prime sub may not yet know if they will be using lower-tier subs or self-performing the work. Even if they do already know, they may not have selected secondary subs yet because they are still trying to lock in the best price or coordinate schedules and capacity.
In large and complex construction projects, there can be multiple tiers of subcontractors involved, making it difficult for the general contractor to have visibility on each layer. This only exacerbates the indirect-relationship issues and makes ongoing coordination even more challenging.
No defined process in project kickoff
It is crucial to standardize project kickoff procedures. This will ensure that the process of outlining who is working on what is consistent from project to project.
A solid project kickoff procedure ensures that all stakeholders are aware and accountable for what they are responsible for both internally and externally. This includes project managers, superintendents, subcontractors, architects, etc.
Here are some best practices for construction project kickoff - specifically oriented to reducing lower-tier risk.
[Internal] Project Managers & Superintendents:
- No unregistered site access. No one should EVER be allowed on site without a COI.
- Monitor for unfamiliar trucks, safety equipment, tools, etc while on site. If you see anyone you don’t recognize, check the schedule and ensure that they are documented or call the project accountant or coordinator.
- Each pay app should include a lower-tier affidavit or list of lower-tiers & lower-tier payment amounts.
- Create a centralized tracking place to track your first and second-tier subcontractors and suppliers and payment amounts.
[External] Subcontractors & Suppliers:
- Make it clear that you will be requiring a list of lower-tier subcontractors and suppliers with payment amounts with each payment application.
- Provide a template - up front - with detailed instructions on how you expect it to be filled out and what each field means.
- Identify any subcontractors that you are unfamiliar with or have been identified as high-risk in your pre-qualification process. Let them know that you will be issuing joint checks to them and their tiered subcontractors & suppliers.
Expectations with prime subs are not properly set
The best place to set expectations is in the contract. Here you can explicitly define what paperwork and reporting are expected from your subs.
The next best place is a project kickoff document. This can be a document or an email that is sent out after bids are awarded to let subs know what will be expected of them on billing.
Poor communication or coordination between the general contractor and the first-tier subcontractor can result in the general contractor being unaware of the specific lower-tier subcontractors involved in the project.
Remember, you will have to repeat the expectations many times over the course of a project but that is part of the constant communication necessary. It is important to not assume the subs are acting with malicious intent frequently, the person on the kickoff or contract signing is different than the person submitting the pay app.
No reporting or documentation procedures
If you do not maintain detailed records or if the subcontracting arrangements are not clearly documented, it is very easy to lose track of the lower-tier subcontractors involved in the project. Additionally, if there is no place where the whole subcontractor stack is documented, it is impossible to hold the stakeholders accountable for accurately reporting on them.
You can’t be blamed; outside of Flashtract the best tool for this is a spreadsheet - and we all know that you already have enough spreadsheets that you are using.
Not a company priority as a general contractor
Let’s face it; your primary subs are going to get the most attention since you have a direct relationship with them. If you have project accountants and/or project coordinators that are already overloaded with checking pay apps and lien waivers, verifying compliance documents, and chasing down unconditional waivers then verifying second-tier subs & vendors can fall pretty low on the priority list. Even worse, is if your project managers are in charge of all of the paperwork and coordination, it falls even lower on the list of things to get done. In this case, it might be time to hire a project accountant.
How do lower-tiers expose you to risk?
The exposure of risk from lower tiers stems from the fact they are less visible and less well-known to the general contractor. This lack of visibility makes it difficult for GCs to accurately assess the financial stability, safety practices, and quality of work of the lower-tiers. To make things worse, lower-tier subcontractors might hire another layer of lower-tier subcontractors, further complicating risk management practices.
The risk of first-tier subcontractors not paying lower-tier subcontractors, and the risk of lower-tiers filing a lien on the project are the most significant ways lower-tier subcontractors can expose a general contractor to legal and financial risk. This can result in costly fines and damage to the company's reputation.
Early warning signs that a lower-tier subcontractor might be about to file a lien or preliminary notice include:
- Tiered subcontractors and suppliers are calling you directly and asking for payment or where their payment is. If you have already paid the prime subcontractor, you should reach out to them and see why they haven’t paid their secondary vendor and subs. If you find that the prime sub is slow to pay, you might consider issuing joint checks to the lower-tier vendors of that subcontractor.
- Lack of communication: If they stop communicating with the general contractor or subcontractor and become unresponsive, it could be an indication that they are experiencing financial difficulties or are unhappy with the progress of the project.
- Project delays: If they stop showing up on the job and/or become unresponsive, it could be an indication that they are experiencing financial difficulties or are unhappy with the progress of the project or the speed of payment.
- Disputes over change orders: If there are disagreements over change orders, payment, or other contractual issues, the subcontractor may feel that filing a lien or preliminary notice is their best option.
- You notice on the second-tier payment list, submitted by subcontractors, the sum total of the outstanding payments to their lower tiers is greater than the remaining balance on their contract. You can only identify this if you have an accurate way of tracking lower-tiers.
By not having visibility into lower tiers, it also becomes difficult to assess the financial stability of first-tier subcontractors. As a general contractor, if you are unaware that one of your first-tier subs owes a large sum of money to their lower tiers, it can put the first tier's financial stability at risk, and therefore, jeopardize the project(s).
Worst case scenario, lower-tiers run into issues of noncompliance with labor laws and regulations. If a lower-tier subcontractor is found to be in violation of labor laws, the general contractor can be held liable for their actions. This can result in costly fines, negative publicity, and damage to the company's reputation. Therefore, having a comprehensive risk management plan that includes lower-tiers and thoroughly vetting and monitoring all subcontractors and vendors involved in your project is important. With ever-expanding regulations, keeping track of all of the different items becomes increasingly difficult.
💡 Coming August 30th! What your subs are hiding from you and why
Items to track to ensure that you are mitigating your second-tier subcontractor risk
Regulations that need to be tracked for lower-tier subcontractors in the construction industry can vary depending on the location, project type, specific trade involved, and the level of relationship equity you have with your subs.
Getting your subs to comply with collection, reviewing, and tracking a lot of this information ends up being a difficult task.
Start with your subcontractor agreements. Use the agreement as a place to explicitly define what you expect from them in regard to when and what documentation is required.
Next, ensure that lower-tier subcontractors have appropriate written agreements in place with the first-tier subcontractor or the general contract, clearly outlining their scope of work, payment terms, and other contractual obligations, including:
- Vendor lists
- Sworn statements
What general contractors should require from lower-tier subcontractors and suppliers via your primary subs
- Licensing and Certification: Ensuring that lower-tier subcontractors possess the necessary licenses and certifications required by local, state, or federal authorities to perform their specific trade or services.
- Insurance Coverage: Verifying that lower-tier subcontractors have appropriate insurance coverage, including general liability insurance, workers' compensation insurance, and any other specific insurance required for their scope of work.
- Safety and OSHA Compliance: Ensuring that lower-tier subcontractors adhere to Occupational Safety and Health Administration (OSHA) regulations and maintain a safe working environment on the construction site.
- Environmental Compliance: Verifying that lower-tier subcontractors comply with environmental regulations and guidelines related to waste disposal, hazardous materials handling, and other environmental considerations.
- Labor Laws and Employment Practices: Ensuring that lower-tier subcontractors comply with labor laws, minimum wage requirements, employee classification (e.g., employees vs. independent contractors), and other employment-related regulations.
- Equal Opportunity and Affirmative Action: Tracking compliance with equal opportunity and affirmative action requirements, particularly for government-funded projects.
- Building Codes and Standards: Ensuring that the work performed by lower-tier subcontractors meets all relevant building codes, industry standards, and project specifications.
- Payment and Reporting: Ensuring that lower-tier subcontractors adhere to payment requirements, submit accurate and timely progress reports, and comply with any specific payment terms or billing procedures.
- Financial Stability: Verifying the financial stability of lower-tier subcontractors to ensure they can meet their contractual obligations throughout the project.
- Prevailing Wage Laws: Complying with prevailing wage laws if the project falls under prevailing wage requirements, which mandate paying a certain minimum wage to workers on public construction projects.
- Tax Compliance: Ensuring lower-tier subcontractors comply with all applicable tax laws, including income tax, sales tax, and payroll tax requirements.
It's crucial for General Contractors to have a robust subcontractor qualification process in place, which includes thorough due diligence and ongoing monitoring to ensure that lower-tier subcontractors meet all the necessary regulatory requirements. Proper documentation and communication throughout the project are also essential to maintain compliance and mitigate potential risks.
At Flashtract, we are here to help. While manual billing, payment, and compliance review processes expose you to risk, Flashtract helps general contractors reduce your legal and financial risk while monitoring for additional revenue opportunities within your existing workflows.