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From IRMI

Diligently Manage Subcontractor Default Risk

Reports of a spike in subcontractor defaults are already surfacing, and most industry observers expect the situation to worsen through 2010 and into 2011. With margins on projects already squeezed by competitive pressures, contractors must take steps now to manage their exposure to this risk. Some basic steps contractors can take include the following.

1. Pick the right people. Use subcontractors you know and with whom you have developed a good relationship. Good communication will be crucial in avoiding bad outcomes.
2. Prequalify all subcontractors at a higher level. Double the frequency at which you review their financial statements. Interview their sub-tiers, vendors, and employees to see if payments are being made on time (make sure you have the contractual right to do so). Ask a lot of questions.
3. Diversify. While it is important to use familiar subcontractors, don’t expose every project you have to the same risk, especially for major subcontractors.
4. Watch for signals of distress. Aging of receivables and payables may be signs of liquidity problems, and a bid that is drastically lower than those of other bidders may signal desperation. Failure to return phone calls or e-mails or to show up at regularly scheduled meetings is a red flag. Train project managers to report any early signs of distress.
5. React promptly. If appropriate, help the subcontractor over a short-term hurdle, but don’t throw good money after bad. Use a funds control service to make sure the funds you pay the subcontractor are being used to pay suppliers and sub-subs on your project. When a default occurs, take remedial steps quickly to avoid a domino effect on other aspects of the project.