The notion that we live in a litigious society is common knowledge, but even so, the lengths people will go to sue a builder are mind-boggling.
Jeff Japhet, a third-generation builder in San Antonio, received a letter a couple of years ago from an attorney threatening to sue him, his father, and his grandfather for damages that a home sustained from foundation movement. However, none of the Japhets built that house. The closest connection they had to the building was that Grandpa Japhet constructed a home next door decades before. That’s the only reason Jeff Japhet, president of Japhet Builders, can imagine to explain why they were even on the radar of an attorney looking to sue.
Though none of the Japhets built the house in question, Jeff Japhet had more tight alibis to lean on in the event that this fact wasn’t enough proof of no liability. He exchanged several letters with the attorney, including documentation showing that his grandfather died in 1991; his father sold his business and retired from building in 2006; and Jeff wasn’t even in the industry when the house was constructed. He was in the U.S. Army’s 173rd Airborne Brigade serving in Iraq and Afghanistan. None of the Japhets could possibly be connected to the foundation damage because they weren’t building houses when it happened.
That still wasn’t good enough for the plaintiffs. So Japhet had to go to mediation and arbitration and present the same documentation to show the arbitrator that he had no relationship to a house that someone else built. “That’s a desperate attorney,” Japhet says. “It just shows you the crap we have to deal with from people who are looking to take money from people who work.”
Japhet’s story is a sobering one, and the experience cost time and money, not to mention peace of mind. Here’s advice about avoiding the stress, cost, and frustration of contract disputes.
Dispute Resolution
Speaking of arbitration and mediation, Ray Truelsen, CEO of Breckenridge Homes, in McHenry, Ill., built more than 600 houses during his 45-year career and went through mediation and arbitration only once. Never again, he says. “I would rather take my chances with a jury or a bench trial where I can tell my story and let someone logical take a look at it, see what evidence is there, and what kind of people you’re dealing with,” he explains.
Truelsen didn’t have mediation and arbitration in his contracts in 2005 when a client inserted a dispute resolution clause into their deal. He decided to take the work and accepted the revision. “She had her lawyer put that in there, so I think I was set up from the beginning,” Truelsen says, in hindsight.
The project had ample allowances for items not specified in the original house plan, and when the time came for the final payout, Truelsen submitted a bill for $148,000. The client balked, claiming the bill shouldn’t be that much and offered to pay just $99,000. Both parties tried mediation, which failed, so the case went to arbitration. Truelsen, the client, and their respective attorneys spent five 8-hour days before an arbitration judge. Truelsen won the case but ended up in the hole financially for that house because he had to split the arbitration cost with the client and pay his attorney. The client actually fared worse because she, too, split the cost of the hearing, and her attorney charged almost twice the disputed difference that Truelsen was trying to collect. He knows how much the client paid the lawyer because she tried, unsuccessfully, to sue him to recover legal fees.
“Arbitration is a waste of money, especially when you really know you are in the right, because the arbitrator basically wants to make things even for everybody. So if you have a good case, you get screwed because you’re being pushed to settle,” Truelsen says.
If a future client were to try to insert a mediation and arbitration clause into his contract, Truelsen says he’d consider it a red flag and would drop the customer. One way to avoid litigation is to filter out potential clients who could turn into future litigants or micromanagers. “You have to do your due diligence in this business because all the liability falls back on the builder—especially if you’re a custom builder because it’s all about your reputation,” says Gus Rubio, president of Gabriel Builders, in Travelers Rest, S.C. “You want to be proactive and take care of this stuff.”
Identifying the crazies
When potential customers interview Rubio as part of their evaluation for selecting a builder, he also interviews them with pointed questions such as: Have you ever built a home before? What was that experience like? Your last builder left a dirty jobsite; describe what a dirty jobsite looks like to you. What specific qualities are you looking for in a builder?
“You start prying to see if some of the stuff they tell you is reasonable,” Rubio says. “I had one guy tell me, ‘I didn’t think it was right for the builder to charge me a markup on things like appliances and lights. We should be able to pick our own lights and not pay markup on it.’ Well, that homeowner is going to be a problem because he doesn’t understand how a builder makes money. The only way we make money is by marking up everything. Who are they going to call when the lights go out or when the dishwasher doesn’t work?” Rubio tries to explain to clients that builders add in the cost of standing behind their work to cover the cost of fixing something that fails, but some clients refuse to accept that answer.
If a potential client previously had a negative experience with a builder, Rubio will ask more questions about that experience to determine if the complaints are reasonable or if the client created those negative experiences themselves. Custom-built home clients typically are high-net–worth individuals and demanding consumers, but some can be more difficult than others. For Rubio, a warning sign can be clients with occupations such as engineer or accountant who could turn out to be micromanagers. Even a recently retired senior executive with a long career of leading people and being in charge may be prone to relieving retirement boredom by trying to manage your project. So another important screening question for clients is: How involved do you want to be in this project?
“The more involved the person is, the more headaches they can cause the contractor,” Rubio says. “I want my clients to go to the job every day, but I don’t want them out there trying to manage my people. That’s our job. I think a lot of legal difficulties in this business could be eliminated by setting up a meeting with clients up front and telling them who the professional is, how the project manager is going to be leading this job, and what everybody’s roles are.”
Using unfamiliar or untested products also can increase risk. Bost Custom Homes, of Cary, N.C., had clients who insisted on using an exotic wood they came across from South America for an outdoor deck. “They found it really cheap, and we said you shouldn’t do that because their manufacturing process down there isn’t as stringent as our local suppliers,” says Evan Bost, director of marketing and building performance. “They did it anyway, and the deck began failing and curling just a year later. We had to eat a bit of that repair work.” Subsequently, Bost Homes’ contracts now state that it will not warranty any product that the builder hasn’t vetted and approved.
Managing Risk
Another way to be proactive about risk concerns trespassing. Generally, property owners aren’t liable for injuries that trespassers sustain while on their property. But there are exceptions that can make the level of responsibility unpredictable and prompt a judge to rule, say, that an owner negligently allowed a dangerous condition to exist, which then became an attractive nuisance and enticed children to play with it. Trespassers can turn out to be anybody, but for an infill project, that jobsite’s most likely unauthorized visitors could simply be curious neighbors.
Before Regency Builders starts fieldwork, the Pewaukee, Wis., builder distributes a letter to every neighbor at least seven houses up, down, and around the jobsite. The letter states that Regency will strive to be a good neighbor while working in their community, and if there are concerns about site condition, parking, noise, or anything else, the letter urges residents to call one of three phone numbers for the company’s two owners or the project manager. The letter also warns about construction sites being dangerous places for children to play and for people to visit, but mentions, “If you’d like a better look at the project, we would be more than happy to escort you on a tour.” Inviting neighbors to visit the jobsite with supervision can assuage the temptation to sneak in.
One of the bigger risks for builders is being liable for damages when their subs are at fault. Regency’s president, Jon Schoenheider, reduces risk by requiring that his company be added as an additional insured to the homeowner’s builder’s risk insurance and to all his subcontractors’ commercial general liability policies. The additional endorsement, also called being coinsured, can defend the general contractor from getting sued for something related to the subcontractor’s work. In one Regency custom home project, a plumber unknowingly broke a faucet on a hot tub. Water flooded the main floor of the unoccupied house, causing six figures worth of damage. Luckily, Regency and its insurance carrier were protected from being sued by the subcontractor’s insurance company because the builder was covered as an additionally insured on the plumber’s policy.
Lien Strategy
Jeff Japhet found out the hard way about the long reach of the lien. He had hired a mason and given him money to buy 50 cubes of bricks, lintels, sand, and cement to start building walls for a project. When the job was finished, Japhet paid the mason the rest of the balance. Later he received a notice of lien from his mason’s supplier. That’s when he discovered that his subcontractor never paid the supplier for materials, and the vendor was going after Japhet for the bill.
“I can try to put a judgment on the mason,” Japhet says, “but what will that do? The guy has no money. As a builder, there is nothing I could do about it. I proved that I paid the guy. I showed the contract, my checks. I showed my bank statement, but it didn’t matter because the supplier was never paid. My contract was not with the supplier. My contract was with their customer, and they could still sue me and lien me for that.”
Since that experience, Japhet now makes a practice of validating who the suppliers are for all of his subcontractors. When he issues payment to his trades, he writes on the check the names of the subcontractor and the supplier. Now both parties have to endorse the check to deposit it in a bank account. If the sub cashes a check without the supplier’s endorsement, that’s fraud.
Gabriel Builders requires that all its trades sign a release of lien before issuing a check. Rubio says he doesn’t have a problem getting lien release signatures, but some builders we spoke with said they hesitate with enforcing that requirement on their subs either because doing so may sour the relationship or the subs simply refuse to sign. Bost Custom Homes also has a mandatory policy that subcontractors provide a lien waiver with their invoice or else the builder will not issue a check. One time a new sub pushed back and didn’t want to sign the lien release until after he was paid. He relented when the builder explained that the language of its assigned lien waiver states that the lien release and certification becomes effective only when payment is received. “It’s not effective until the subcontractor gets paid, but we want to make sure we get the waiver ahead of time, so we don’t pay someone and then have to track them down in order to get it,” Bost says.
Glenn Carter hasn’t had a lien or lawsuit successfully filed against his business, Advanced Building Consultants (ABC), in more than 20 years, which is about when the president of the Renton, Wash., company adopted a business model that significantly reduces his liability and cost of insurance.
Shedding Contractor Liability
During the late 1990s, Carter was building and remodeling houses as a general contractor and didn’t like the enormous amount of liability he had to assume even though all of his subcontractors also had liability insurance for their parts of his projects. Carter also disliked the general contractor game of trying to make more money from clients by selling change orders, finding mistakes in the drawings that he could charge for, and piling on other extras. His fees were climbing, partly to cover the cost of insurance, and potential customers couldn’t afford to hire him.
“I didn’t want the liability, and I didn’t want to charge my client these exorbitant fees that general contractors have to charge to cover their absurdly high and unreasonable liability,” Carter says. Then he met a client who at one time considered building his house by being his own general contractor with assistance from a now-defunct consulting company called Homes Now. By coincidence, Carter had attended a Homes Now seminar to find out about what the company was teaching homeowners and was intrigued by the business model. When he discovered that the client possessed a Homes Now contract, Carter asked to see it. He used that document as a beginning template to transition from general contracting to construction management.
During that first year, Carter gave clients the choice of having him work for them as either a general contractor or as a consultant for a fixed fee. As a consultant, Carter would prepare cost breakdown documents to submit to the bank, facilitate bids and negotiate contracts with trades and suppliers, manage the construction schedule, handle change orders, and track invoices, just like a contractor. He would be involved in a project from before the land was bought until long after the homeowner moved in. The difference was that Carter didn’t sign any contracts or pay the bills. The homeowner did that.
When ABC pulled a building permit, it was in the client’s name and paid for with a check from the client. When Carter tracked invoices from the subs and payment was due, he would forward the bill to the homeowner with instructions to write a two-party check with the names of the subcontractor and the sub’s supplier. In Washington state, any person providing materials, equipment, or professional services for the improvement of real property must send, by certified or registered mail, a notice of their right to claim a lien to the property owner. Carter tracks those notices too, so he can tell his client the name of the supplier to include on a two-party check submitted to the subcontractor.
The benefit for Carter was he didn’t have to buy expensive general contractor’s liability insurance. He merely needed an errors and omissions policy to cover him and his employees while they managed the project. That meant much less liability for ABC. The benefit for the homeowner: Carter could work for them at a much lower fee.
“Clients understand what’s going on,” Carter says. “They understand that it is them and me on one side of the table and all the rest of the subs and suppliers on the other side. Before, it was me on one side of the table and them on the other side. Now we’re working together. We’re a team.”
During the first year, all of Carter’s customers chose to hire him as a consultant. He shut down his general contracting division the following year and now exclusively builds custom houses as a construction manager. He has since had that contract scrutinized and revised by lawyers, accountants, and audit specialists so his business isn’t entangled with the liability that typically falls on a builder. ABC also has been audited and deemed a professional service provider by the Washington State Department of Revenue, and, unlike a general contractor, professional service providers aren’t subject to the state’s sales tax, which is another advantage.
“All I had done was rediscover the profession of construction management and applied it to custom home construction,” Carter says. “I’m doing that with a contract that keeps me out of liability and allows me to charge less and fix my fee, which everyone loves.”
Getting Paid
Disputes with clients tend to percolate during the construction phase and boil over when change orders and allowances push the bill to a level beyond what the client originally expected to pay. However, if a project is funded by a construction-to-permanent loan, the builder can draw on funds from an escrow account after the bank inspects and verifies that stages of construction have been completed. That arrangement makes it more difficult for a homeowner to withhold payment based on a whim. Carter structures the payment of his fee starting with 15 percent up front, followed by increments paid upon attaining construction milestones such as completing the foundation, the roof, and occupancy. “We hold out 10 percent for the occupancy payment just in case someone doesn’t want to pay,” Carter says. “That has been rare, but it’s just 10 percent, so it’s not the end of the world if it happens.”
A good set of plans with abundant detail can go a long way toward avoiding the final-bill surprise and maintaining the client’s trust. Rubio recalls architectural drawings on a project for a space that simply had dash marks that he and his managers thought represented two beams. So they budgeted $5,000 per beam or $10,000 for an allowance. Construction started, and three modifications later, the architect was specifying as many as eight beams with tongue-and-groove ceilings, pushing the cost to $40,000.
“I like as much detail as I can have, and I like my plans to be finished,” Rubio says. “If we start a project and the plan is 80 percent finished, we’re going to look bad because the architect is drawing in all these details for which we never had allowances or pricing. Then the project turns sour and we look like the bad guy because we have to go to the homeowner and say this project is going to cost more than what we originally budgeted. Some builders take advantage of that, but I don’t. I’d say a good project starts with a detailed set of plans, and that eliminates a lot of legal issues.”
There will always be difficult clients, litigious people, and even those who need to create drama when a project is going smoothly. Trying to exert control over factors like those is a fool’s errand. But protecting yourself as much as possible from the unpredictable will help protect your business.