Although the recession may finally be coming to an end, commercial lenders remain reluctant to provide money for new construction. Many surviving contractors are taking jobs for small profit margins, if any. Where else can contractors turn to find work? Try the government sector.

Fundamentally, the only difference between commercial and government contracting is the source of the money. As the name suggests, government contracts are generally funded with public tax dollars instead of dollars from banks, investors or other private sources.

However, there are quite a few strings attached for contractors engaged in public contracting. And there is more on the line for contractors who fail to follow the unique rules and procedures of the public procurement code, including civil and criminal penalties. So it is crucial to become familiar with those rules before contracting with government agencies.

Here are some of the important differences between private and public procurement contracting. The focus is on federal projects, because state and local agencies generally follow the federal government’s lead in regard to contracting rules.

Getting paid

In the commercial contracting world, many project owners have filed for bankruptcy as property values have plummeted and construction funds have dried up. As a result, many contractors have gone unpaid for their work. On the other hand, public contracting entities must formally appropriate, and as such, set aside money for projects prior to entering into contracts. Accordingly, the risk of not getting paid is much smaller on government jobs than on private ones.

Competition in contracting

In the private world, owners have complete discretion on how to let a contract, with whom and under what terms and conditions. Competition is optional. In contrast, government agencies must follow strict rules – with a strong preference for competition. The agency will typically issue an invitation to bid for hard bid/low price competitions or a request for proposals for negotiated contracts. With one limited exception (where there are few or no other contractors willing or able to perform certain work), the successful contractor will have to compete with others for one or more portions of the work. Accordingly, the rules provide a fair opportunity for all contractors to be selected.

Bid protests

If an agency were to fail to follow procurement rules when entering into a government contract, “disappointed bidders” (those not awarded the contract) could file a bid protest to prevent the agency and the successful contractor from proceeding. The time deadline for filing a protest is short (typically between seven and 10 days from notification) and protesters must strictly follow the rules. On the other hand, the private sector presents no opportunities to challenge an award because owners are free to contract with anyone they choose. A successful protest presents a unique opportunity and a powerful tool for contractors to require an agency to either rebid the contract or revise the contract award.

Change orders

Both private and public contracts typically contain change order provisions that let the owner make changes within the general scope of the contract. However, the changes clause in a government contract is far more powerful because the government can unilaterally require a contractor to proceed with change order work without agreement on an adjustment in contract price and time. In a private setting, it is common for contractors not to proceed with work without agreement on the change order. As a result, government contractors must be prepared to “carry the contract” while working out a resolution on a disputed change order. The good news is that generally the contractor will get paid; it just may take some time.

Broad audit rights

Because tax dollars are at stake, agencies take special precautions to track money used on public jobs. While private contracts may also contain owner audit rights (especially on cost reimbursement as opposed to fixed-price contracts), the government’s rights are far broader, requiring contractors to follow strict accounting rules and open their books (and their subcontractors’) upon demand. While large government contractors are accustomed to such periodic audits, smaller and less sophisticated contractors may consider this somewhat burdensome and an “invasion” of their business.

Authority of the government contracting representative

Project owners typically have representatives who sign contracts and authorize change order work. If it turns out on a private job that the representative did not have actual authority to direct a contractor to proceed with certain work, the contractor may still have recourse against the owner under the theory of apparent authority. In government contracting, the concept of apparent authority in this context does not exist. The government’s representatives, called “contracting officers,” have only such authority as specified in a written “warrant” signed by the head of the agency. This authority usually allows for the base contract amount plus a reasonable volume of change orders. However, in the case that significant project changes are required, contractors should take care to ascertain the CO’s authority prior to proceeding with work. If the contracting officer agrees to modify the contract above the amount authorized, the contract becomes invalid.

False claims and criminal sanctions

The stakes are greater in government contracts because the government can impose civil and criminal penalties for failing to follow the rules. These severe sanctions, including hefty fines or even imprisonment, surface when contractors make “false claims” (whether inadvertent or intentional) – such as, for example, providing inaccurate data during a contract negotiation or submitting a payment application reflecting inaccurate information. Contractors that take on such jobs should ensure that compliance is monitored internally. In contrast, contractors can use just about any negotiation tactic on a private job, and owners may provide leeway when reviewing payment applications.

Marcus Eyth is of counsel in the Portland office of Davis Wright Tremaine LLP. He advises and represents U.S. and foreign companies on all aspects of construction and government procurement contracting, commercial transactions and litigation matters. Contact him at 503-778-5324 or marcuseyth@dwt.com.

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Lots of people in the construction industry have been talking about public-private partnerships recently. But many folks aren’t really sure what a PPP is, don’t understand the players and their roles, and may not recognize the risks and potential benefits.

PPPs have been used in the U.S. for more than 225 years in various forms, and include wildly successful and famous projects such as the Erie Canal, the Holland Tunnel, Grand Central Terminal, the Brooklyn Bridge, the New York subway and the Boston subway.

Fundamentally, PPPs consist of a contractual relationship between a public agency and a private entity (usually referred to as a “concessionaire”) with a purpose of delivering a service or facility for the use of the general public. Stated differently, the agency and the private entity jointly supply money to build, operate and maintain a public project, with both sides sharing the risks and rewards of project delivery.

Unlike the traditional government contracting scenario, in which the government appropriates money to procure the services of a contractor to build a project, the private entity’s investment results in balancing the risks. In consideration of taking on more risk, the concessionaire – for a certain term – obtains the revenue from the completed project.

There is some PPP activity in Oregon, but not much, which is likely due to a lack of investors and a lack of understanding of PPPs. But in a down economy, when contractors are struggling and agencies lack money to pay for infrastructure projects, PPPs can put contractors back to work.

In 2006, the Oregon Department of Transportation signed a PPP with a consortium of private-sector companies known as the Oregon Transportation Improvement Group to assess and possibly deliver new transportation infrastructure projects to Oregon.

More recently, Portland General Electric and ODOT entered into a PPP to create and operate a solar power plant for a “solar highway” project. This first-of-its-kind PPP produces solar energy during the day to illuminate the highway interchange from Interstate 5 to Interstate 205 south.

Typically, the concessionaire (usually a special purpose entity) will engage the various project participants, who may include lenders or investors, designers, a construction contractor or contractors, and a company to operate and maintain the completed project. The concessionaire is the equivalent of a “one-stop shop” so that an agency does not have to enter into separate agreements with – and manage – the various participants.

Concessionaire agreements are usually heavily negotiated to strike a fair deal that balances the risks and rewards to the agency, the public and the concessionaire. For example, while a state transportation agency may want to limit toll rate increases (to protect the public from an overreaching concessionaire), the project needs to be attractive enough for investors to earn a reasonable rate of return.

Another key provision is the term, which typically ranges in the U.S. from 25 to 99 years. Concessionaires will typically desire a longer term to realize the benefits of the initial capital investment over time. Moreover, the parties will need to consider what standards the concessionaire will be required to meet for project maintenance during the term. Those costs can vary significantly, depending on quality.

In addition, as in a real estate lease, the parties will need to consider in what condition the facility will be returned to the agency at the end of the term and what measures will be in place to guarantee that condition (e.g., surety or cash bonds). Other considerations include what happens if the concessionaire goes bankrupt and how the agency ensures that the concessionaire complies with existing and future environmental standards.

Oregon has some of the least restrictive PPP laws among the approximately 25 states that permit PPPs, which means there is room for more creative proposals. Although many of the design-build contractors involved in PPPs are large firms, it is not uncommon for medium-sized contractors to team up and create joint ventures to compete for this work. Even if smaller contractors are not privy to the concessionaire agreements, they (and trade subcontractors) have incentive to support PPPs because they present work opportunities in this down economy.

For concessionaire participants, rewards include financial gain, experience, good public relations (also for creating jobs) and a busy workforce. But the risks can be significant too – especially when the private partner initiates the proposal. Start-up investment costs used to convince an agency and/or specific politicians of the benefits and long-term viability of a proposed project may not be recouped.

By way of example, the proposed high-speed rail PPP project in Florida in 2010-11 attracted a number of national and international design-build contractors, some that established entities in Florida, hired personnel, entered into equipment purchase and rental agreements, and courted the agency for many months. Unfortunately, the project was terminated by Florida’s governor, who decided it was not in the state’s interest to proceed.

But for savvy, creative and well-connected investors and contractors who keep their eyes open to risks, public-private partnerships present a valuable alternative or supplement to standard procurement contracting.

Marcus Eyth is of counsel in the Portland office of Davis Wright Tremaine LLP. He advises and represents foreign and U.S. companies on all aspects of construction and government procurement contracting, commercial transactions and litigation matters. Contact him at 503-778-5324 or marcuseyth@dwt.com.

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In the aftermath of the housing boom, there has been an increase in construction defect litigation, especially for condominium projects. Those claims frequently involve water intrusion resulting from improper construction methods, or the use of defective siding, roofing, windows or other materials.

So, how can a building owner best protect against these issues? After all, most contractors don’t have the financial means to remedy substantial construction defects.

Insurance would seem like the logical answer, provided it actually covered the loss; however, seemingly obvious problems may not be covered.

There are insurance programs, such as the so-called “wrap policies,” designed specifically for condo projects. Under a wrap policy, all parties – including the owner, the contractor and subcontractors – participate in a single insurance program controlled by the owner or the contractor.

This can be an efficient way to manage insurance on a project, but the policy is only as good as its coverage. Too often, those who participate don’t actually take the time to understand the limitations on coverage. And those limitations can make the policy frustrating.

One reason why some folks don’t take time to understand the policy is because the document may be up to an inch thick, double-sided, and contain fine print from beginning to end. Navigating through a policy may seem like it requires some kind of special training or doctorate degree. To most people, insurance policies are just that: a tedious, boring and tough read.

The first step in understanding the scope of coverage is to realize that an insurance policy is like an onion. It starts with a set of documents that call out various definitions and coverages in the generic, all-inclusive form. Then a second set of documents known as the “exclusions” limit the very types of coverages expected from the first set of documents.

The concept is not much different than an average auto or homeowner’s policy, which most readers will admit they regularly renew despite not having read it or reviewed it in years (or ever). Slowly but surely, layers of coverage can be peeled away to reveal the policy’s scope. Trying to determine what is left after applying the exclusions is an art that neither insureds nor insurers have been able to master given the flood of insurance litigation in the construction defect world.

So, are construction defects covered? That depends on whether the issue constitutes an “occurrence” and “property damage” as defined in a policy. And identifying “property damage” can be trickier than one may initially think.

For example, a construction defect may result in excessive noise traveling between condo walls. The defect does not physically impact real estate, but does it constitute “property damage”? A case could be argued either way. The good news from the insured’s perspective is that if the definition in the policy is ambiguous, the case law holds that the language of the policy will be construed against the insurer.

But even assuming the damage qualifies as an “occurrence,” there will be other hurdles to overcome before coverage is triggered – i.e., the exclusions.

For example, a “completed work exclusion” may provide, in essence, that insurance does not guarantee the contractor’s workmanship.

Then there may be a so-called “ongoing work” exclusion that excludes coverage for damage caused to property while the work is being performed. So, if testing of the portion of the work (e.g., acoustical testing) during construction indicates that work is defective, the owner may not be able to trigger insurance to fix the problem.

In addition, there could be a “cross-claims exclusion,” which, under a wrap policy, prevents plan participants from suing one another for issues that otherwise would be covered by insurance. In other words, there must be damage to – and a claim from – a third party for coverage.

While this may seem counterintuitive (defective construction is defective construction no matter who is damaged or brings a claim, right?), this is how the insurance game is played. And in some cases, building owners don’t understand what their policy actually covers until it is too late.

So, how does a building owner stay protected from damages resulting from shoddy construction work?

First, perform due diligence on the contractor to determine its reputation and financial backing. For obvious reasons, some contractors (and owners, too) form “shell” entities with no assets for a particular project, leaving the owner with a judgment against a contractor worth less than the paper the judgment is written on.

Second, procure and maintain insurance, but be sure to understand what coverage is being purchased. At least take time to sit down with an insurance broker, an attorney or a knowledgeable friend who can give a layperson’s translation of what the policy actually covers.

Then denial-of-coverage letters won’t arrive unexpectedly. And there will be no need to ask an insurance broker: “Why did I spend all that money on insurance if it doesn’t really cover what I thought it would cover?”

Marcus Eyth is a construction law and government contracts attorney in the Portland office of Davis Wright Tremaine LLP. Contact him at marcuseyth@dwt.com or 503-241-2300.

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“Where did all the money go?” Lately, this question has been on the minds of many building owners who pay general contractors expecting they will use those funds to pay their subcontractors and suppliers for work done on projects. These days, owners have less reason to assume the funds will get there.

Given these trying economic times, it appears some overextended and cash-strapped general contractors may be using money received for current project work to pay off subcontractors for work on previous or concurrent projects. As a result, unpaid subcontractors turn to lien laws that protect them from nonpayment.

And if worse comes to worst, the owner could end up paying twice for the same work: once to the general contractor and a second time to the unpaid subcontractor. Even worse, the owner’s property may be foreclosed in the process and sold off to satisfy the debt. This presents a potential double-whammy, leaving an owner to defend expensive and time-consuming lawsuits while its project (or investment) is stalled or terminated.

In a nutshell, construction liens are like security interests created by statute as a vehicle to help contractors get paid for work completed on privately-owned projects. Provided an unpaid contractor strictly complies with all notice and timing requirements, it may file a claim of lien (in essence, a formal “heads-up” to inform the owner of a payment issue), followed by a lawsuit to enforce the lien. If the case is not settled, the property is sold and the proceeds from the sale are used to satisfy amounts due the contractor.

How can an owner ensure that the money it pays the general contractor will reach the appropriate subcontractor? It can’t. But there are steps an owner can take to reduce the risk of exposure to lien and other claims filed by subcontractors on projects. A little due diligence, some awareness and a well-drafted prime contract addressing the following issues go a long way toward achieving that goal.

1. Know the subcontractors. Keep track of the trade contractors who should receive money from the general contractor by including a provision requiring the general contractor to either identify any desired subcontractor or seek the owner’s approval of any proposed subcontract. If your general contractor terminates a subcontractor or enters into multiple subcontracts for the same trade, this should raise a red flag that payment issues are on the horizon. Of course, confirm whether the general contractor is reliable and has the resources to do a job before awarding the project.

2. Notice of claims, offsets and indemnification. Include a provision requiring the general contractor to notify the owner of any claims made. Early notice of claims is crucial for the owner to protect itself by, among other things, withholding payment to the general contractor. Also provide for an owner’s right to offset, back-charge and/or withhold payments under these circumstances when subcontractor claims surface. Another form of protection is a broad indemnification provision that requires the general contractor to defend and hold the owner harmless from third party claims. Finally, the general contractor should be required to promptly bond-off any filed liens.

3. Lien waivers. Require the general contractor and subcontractors to execute broad lien waivers as part of the payment application process. Owners should take special care to prepare appropriate language for lien and claim waivers, which should, among other things, require: the general contractor to affirm that it has paid its subcontractors from amounts previously paid by the owner, and the subcontractor to affirm that it has been paid out of amounts paid to the general contractor. Properly drafted lien waivers constitute persuasive evidence for courts considering the dismissal of lien claims.

4. Direct payment to subcontractors. Reserve the right to make payments directly to subcontractors. This is effective because liens are discharged to the extent the debt has been paid. Frequently, owners will issue joint checks to the general contractor and the subcontractor when payment issues surface. While attractive in theory, this concept of dual payment has its own risks, whereby the general contractor might misappropriate the money after endorsement by the subcontractor, thus still leaving the subcontractor unpaid. Issuing joint checks also raises other contractual (so-called third-party beneficiary) issues, which could expose the owner to direct claims from the subcontractor.

5. Payment bonds. Require the general contractor to procure a payment bond, whereby a surety is charged with handling lien and other claims that are unpaid by the general contractor. While the payment bond does not automatically discharge a lien, it indemnifies the owner against claims in the event of a default by the general contractor. It goes without saying that a general contractor would be in default for using funds received from the owner to pay off subs on other projects.

Most experienced construction lawyers will acknowledge that there is no such thing as a fool-proof construction contract for any project. However, owners will be best positioned to limit their exposure to lien and other claims if they: first, have a favorable contract that they understand and enforce; and second, stay actively involved in the project on a day-to-day basis to recognize and address payment issues as soon as they surface.

Marcus Eyth is a construction law and government contracts attorney in the Portland office of Davis Wright Tremaine LLP. Contact him at marcuseyth@dwt.com or 503-241-2300.

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