The impact of a sudden shift from record high demand last summer to cancelled projects, depressed markets and falling materials and labor costs this spring has spurred a once-in-a-generation poker game of renegotiation on projects across the country.
While many in the industry are reluctant to discuss the trend for attribution, industry sources say the temptation for owners to renegotiate pricing is widespread. Here is the scenario: materials costs were rising across the board in the spring and summer of 2008. Owners, eager to lock in prices, pushed their general contractors and subcontractors to lock in their numbers. Many of these projects are now moving into the construction phase amid falling prices.
At first blush, most in the industry think that contract language, ethics, and industry business practices would inhibit this type of renegotiation, particularly when subcontractor and materials supplier contracts have been signed. But that’s not necessarily the case, say industry sources. The old adage, “He who has the gold makes the rules,” is often proving stronger than contracts or ethical considerations.
“It’s happening across the spectrum; everybody’s trying it,” says Don Short, CEO of Tempest Co., an Omaha-based independent estimating consultant, and a board member of the American Society of Professional Estimators. “The temptation is too strong.”
“Owners are out there fishing to see if they can get a better number,” says Chris Zaucha, vice president of Innovative Glazing Systems Inc., Lansdale, Pa., and a member of the executive committee of the Construction Financial Management Association. “It’s a touchy subject. As a subcontractor it puts you in a difficult spot.”
The impact is highest on longer duration projects in the power, process and industrial sector where projects may last for years, but any project with a duration of more than 12 months that locked in pricing before last fall is in play.
Some owners are ethical in their approach, working with their selected general contractors and subcontractors. Others are cancelling contracts or strong- arming subcontractors with the threat of cancellation to get reduced pricing. Either way, and regardless of contract or legal remedies, Zaucha says renegotiation of existing contracts is a big concern for subcontractors this spring: “It’s an eight or nine on a scale of ten,” he says.
One example of renegotiation is a major mixed-use development in the Buckhead district of Atlanta, called Streets of Buckhead, led by developer Ben Carter Properties. The multi-phase $1-billion program started its first phase of roughly $150 million in late 2007. At the end of 2008, the development landscape was fundamentally altered and the first phase 40% complete. In mid-January, the developer stopped work, terminated all contracts and put bid packages back out on the street to capture lower pricing.
“We locked in prices at the high end of the market,” says James Woodcox, partner and executive vice president of Ben Carter Properties, Atlanta. Given the economic outlook and the depressed market for leasing, he says, “We were forced into a situation where we had to get some money out of the construction cost.”
To bring down costs, the developer and its construction manager, Balfour Beatty Construction, Dallas, “sat down and renegotiated with a handful of subcontractors” representing about 25% of the total cost of work, says Woodcox. Other contracts were terminated and re-bid.
Woodcox says work will restart in May on phase one. While bids have not been finalized, he expects to see an average reduction of roughly 10% in subcontract costs. He says the developer made every effort to pay existing subcontractors what they were owed.
“Ninety-nine percent of the subcontractors were understanding and very gracious about rebidding,” says Woodcox. “This is something you would never do if you could help it and I hope I never have to do it again.”
There is a fine line between ethical and unethical renegotiation, says Paulette Rutlan, current president of the American Society of Professional Estimators, and CEO of independent estimating consultancy CCC, Irvine, Calif. “As long as you’re working with the original GCs and subs, I don’t think there’s anything necessarily unethical about it,” says Rutlan. However, she says subcontractors should be entitled to their original profit, even if materials costs are reduced.
Collette Nelson, executive director of the American Subcontractors Association, is more blunt in her assessment of renegotiations. Saying that a contract should be honored, just as subcontractors have historically been at risk to cover materials cost increases after a contract is signed, she says, “Should an owner or GC beat down their subs just because they can? It’s just offensive.”