Construction project success depends on ever-changing factors, as well as the adaptability of the parties to mitigate risks that accompany such change — which is now more apparent with the influence of COVID-19. This article will provide an overview of the benefits of subcontractor prequalification, a summary of impacts from COVID-19 on prequalification, trends from the surety perspective, and best practices to ensure a more cost effective and profitable future.
How Can Subcontractor Prequalification Benefit the Contractor?
Awarding work to an unqualified subcontractor may lead to delays, budget overruns, and poor work quality. Contractors can mitigate these undesirable results through prequalification to assess a subcontractor’s qualifications, save time and money, and reduce risk.
The 3 Cs of Prequalification
Essentially, subcontractor prequalification criteria are akin to that of the surety bond underwriting process. To determine whether to prequalify a subcontractor, contractors should gather information from each of the three “Cs” — capacity, capital, and character — in order to gain insight into the overall capabilities of the subcontractor.
The contractor should evaluate the subcontractor’s ability to handle certain project types and sizes, including analysis of the subcontractor’s manpower (whether the subcontractor has to broker labor or if its labor force is internal); geographical location and reach; and if the subcontractor has the necessary skills, knowledge, and experience required for the projects and work in which it will be contracted to perform.
The information gathered will allow the contractor to comprehensively examine whether the subcontractor has the requisite skills and workforce necessary to complete a project in accordance with the contract documents and/or mitigate unanticipated delays due to an external labor shortage.
The contractor should assess the subcontractor’s financial stability by carefully examining its balance sheet, working capital, cash flow, financial history, and current year revenues (see “CFMA’s 2021 Construction Financial Benchmarker Executive Summary”).
The subcontractor’s financial health information can provide the contractor with assurances that the subcontractor will be able to weather any financial downturns, continue its performance on a project, and make timely payments to downstream subcontractors and suppliers, thereby avoiding any future bond or lien claims.
The contractor should evaluate the subcontractor’s reputation and standing in the market, including its professional history, banking relationships, payment practices, litigation, past claims, and safety incidents. This information can be used to generally determine the subcontractor’s reliability within the industry.
Utilizing Prequalification Information
Overall, the information gathered during the prequalification process is used to formally vet proposed subcontractors and identify any red flags that may lead to inefficiencies in time and performance of its work. In other words, the information can play a key role in mitigating risk.
Subcontractors can also benefit from the prequalification process. For example, subcontractors may obtain certain financial incentives from the contractor for prequalifying, and the subcontractor will have the benefit of knowing it is working with other qualified subcontractors on a project, thereby decreasing certain project performance risks (e.g., delays). Accordingly, implementing a subcontractor prequalification process can limit risks of undesirable project occurrences such as delays, defective work, and default.