AMA - Contractor Underbid The Job

Ramon asks,

I recently purchased a small multifamily property at which I am doing a renovation project with a budget of approximately $300k. My contractor and I have a long relationship, spanning more than 10 years, and have successfully completed numerous projects together. At the beginning of the project we defined a clear scope of work, timeline and payment schedule. After getting off to a good start, we are now 8 weeks behind schedule and I’m noticing some work that is not up to his typical high-quality standard. I had a conversation with him about these issues and he said that he underbid the job and wasn't making any money, but despite that he plans to honor the deal (he pointed out that many contractors would just abandon the job in that situation). I believe that because of this underbid he is skimping on certain things and has a smaller crew than is required to speed up the process.

As I see it I have 3 choices: (a) I can let him finish which will likely result in the project falling another month behind schedule, (b) I can increase the agreed upon price if he agrees to hire more people (this may be a wash compared to the extra holding costs if I go with option (a)) or (c) fire him and hire a new contractor to finish which will likely result in more delays. How would you approach this situation?

Ramon, This is a great question.

It does happen that contractors underbid projects. When they do underbid, they start taking steps to protect their profit margin. They use lower cost labor. They start pulling quality out of your project and using cheaper materials. They slow down to preserve cash flow since they’re going to be losing money. They will do more of the work with in-house labor instead of using the proper subcontractor for the work.

They will cut corners at every turn. Put yourself in their shoes. You would do the same thing. Even good people make mistakes.

I don’t think you should just let him finish the contract, even on a slower schedule. I believe that the impacts will extend beyond just time. You will find quality and materials will be short of your expectations.

If you fire the contractor, there will be costs to break the contract. The contractor will claim that they are owed money for work completed. From there, you will bring a new contractor into the job. They will recognize that the job was underbid, and they will make sure that they don’t lose money. So you will definitely pay more. By the time you put the project out to bid, you will lose even more time and you will definitely pay a lot more. If you don’t agree on the amount owing to the previous contractor, you can expect a mechanics lien on the property, in which case your lender and a new contractor will have a problem with the presence of the mechanics lien. Think about it, would a new contractor take on a project knowing that he might not get paid?

I would recommend the following.

1. Require complete transparency on the scope of work.
2. Agree on a fixed profit margin for the GC. If their normal profit margin is say 10%, you’re going to agree on a haircut for that number, maybe 5%, or better still a fixed amount and it won’t be payable until the job is done.
3. Review the scope of work and get agreement on the pricing for all the subs and in-house labor. In-house labor would be treated the same as a subcontractor for the purpose of the
4. You can at that time value-engineer any of the finishes and make material tradeoffs yourself. I don’t know the details of your project. So I’ll just through out some ideas for you to explore. You might choose a less expensive flooring material, or eliminate the trench drain in the showers for a lower cost center drain. You might choose a lower cost granite for the kitchen counters, or lower cost windows.

You can recover some of those costs in a value engineering exercise.