Six Percent of Construction Industry Revenue Lost Annually
In most cases, general contractors have strong relationships with their subcontractors, but fraud is prevalent in every industry, and construction is no exception. As a risk management measure, it’s important to recognize typical subcontractor fraud schemes so you can protect your construction company both financially and legally.
Bid rigging and price fixing occur when subcontractors collude to control who wins a project, undermining the competitive bidding process and driving up job costs. This often occurs through the following schemes:
Bid suppression. Subs agree to submit few, if any, competing bids. Thus, they limit the number of bids so a predetermined “winner” gets the job.
Complementary (or “courtesy”) bidding. They submit proposals with exclusions or conditions that disqualify them, while the predetermined winner submits an acceptable bid. Complementary bids often come from shell companies, who submit bids without the intention of being awarded the work, to create the false narrative that multiple bids are out at similar prices, etc.
Bid rotation. Here, subs share pricing info among themselves so they can price bids accordingly and take turns winning projects.
Guaranteed subcontracting. In these instances, subs enter bids that don’t encompass the entire scope of work. This way, each cooperating company can be awarded a piece of the project by the predetermined bid winner.
Market division. In these instances, subs agree to divide markets or product lines while also agreeing not to compete in each other’s territory. Other threats
A subcontractor can also “go rogue” and perpetrate fraud all on his or her own. Among the most common ways is billing for unperformed work by overstating units of production, units of labor or equipment used.
In addition, beware of subcontractors billing for higher-grade materials but using lower-grade products instead. This type of fraud results in poor project quality and can cause costly, dangerous structural failures. Also, keep an eye out for subs removing materials, tools or equipment from jobsites for their own use or to sell.
If a subcontractor pushes for a change order, proceed cautiously. It may be a valid response to changing conditions, but it may also be an attempt to expand the base contract’s scope to earn the subcontractor more money. Review the proposed change carefully, considering the contract terms and design specs.
There are various best practices for preventing subcontractor fraud schemes. For starters, know your market. Keep tabs on the costs of materials and services, including reasonable bid pricing on comparable projects. If you’ve been in business awhile, your experience should serve you well.
Next, refine your subcontractor selection process. Ask to see licenses and proof of insurance. Perform background checks for tax liens, lawsuits, code violations and criminal convictions. Then, use this to create a prequalified subcontractor list of trusted providers. You can also research previous projects for information such as scope and budget accuracy and performance. This information should be available for all publicly funded projects.
Retain the right of first refusal to reject bids and reopen the request for more proposals. Sometimes, in an effort to limit collusion risks, you may need to open the process to a wider geographic area to draw a broader group of subs who are less likely to collude.
Finally, ensure your project management is up to speed. Review invoices, compare actual-to-budgeted job costs on a line-item basis, and document your efforts diligently. Perform regular jobsite inspections so your presence is known. Use photos or video to track and document workers’ activities and the current location of materials and equipment.
It could happen
Again, under most circumstances, working relationships between general contractors and subcontractors are based on mutual respect, trust and teamwork. But that doesn’t mean you should operate under the blanket assumption that “fraud could never happen here.” It could — unless you take steps to stop it. Contact Kerri Richardson with VonLehman’s specialized Construction and Real Estate Group today at firstname.lastname@example.org or 800.887.0437.