Webinar: How to Protect Payments During Construction Bidding

Payment rights begin at the bidding stage and set the tone for the entire project. In this expert webinar, we’ll cover:
– Critical effects on payment during the bidding stage
– How to accurately predict costs to calculate markup
– Steps to take and contract tips to protect payment rights

Our Experts for this session are:
– Peter Ryan – Attorney, Hunt Ortmann Palffy Nieves Darling & Mah, Inc.
– Matt Viator – Senior Legal Associate, Levelset

Full Transcript

Matt:
All right, so I’ll introduce myself first. My name is Matt Viator. I’m a senior legal associate here at Levelset and one of the main projects that I work on is the expert center and that’s, for those of you who may not know, that is a forum where construction industry members can ask questions and receive answers from construction attorneys like myself and Peter. And we think that’s a really great resource and can help answer a lot of questions that you may have. And so during this program today we will answer some questions throughout and then hopefully some at the end. But if you do have any questions that aren’t addressed, feel free to post those on our expert center later on. Like I said, attorneys such as myself or Peter will be available there to answer some questions you may have.

Matt:
But now for the big show. Today we have Peter Ryan from Hunt Ortmann and we’re going to be talking about protecting payments during construction bidding and specifically how to avoid payment issues from day one. This is an issue that’s really near and dear to Levelset’s heart because we’ve always said that by the time you hit a construction payment issue, a lot of the time, if you didn’t prepare for it properly, it’s going to be a lot harder to resolve that later on than it would have been if plan properly from day one. So this is near and dear to us. For a little bit more about Peter, he’s out of asking in California, again Hunt Ortmann. And so some of the topics that we’re going to cover today are going to be the critical effects on payments during the bidding stage, how to accurately predict costs and to calculate your mark-up and then steps and contract tips to protect payment rights. So it’s probably enough talking from me. So without further ado, Peter, go ahead.

Peter:
Hi everybody. As you mentioned, I’m Peter coming from Pasadena, California. Today I’m just going to go over some elements of the bidding process and also how we can protect payment rights from this early stage. Just as a preliminary matter, I wanted to start and just go over the mechanics of the construction bidding process and specifically the different types of bidding processes that there are. Generally there are three different types of bidding that is set out to bid. Probably the most common is the competitive low bid and this type of bid selection, it’s usually primarily for design-bid-build projects and is called… And under this selection process, the lowest responsive bidder will be selected without consideration of relative qualifications of the bidders and a bid is responsive if it meets the requirements of the bid documents and is provided by a qualified contractor, meaning any contractor that meets the minimum qualifications described.

Peter:
But the second type of bid competition that occurs is basically a best value competition. So in this case, the bidder that’s going to be selected is the bidder that presents the best value in terms of both amount of the bid and also qualifications. And a lot of public entities will have rating systems that they factor into when considering the bid and whatever the ratio they apply is, the bidder that’s considered the best value will be the one selected.

Peter:
A final type of bid selection process that occurs is just solely based on qualifications. This usually occurs in projects that require an integrated project delivery system and under this bidding system the focus is not on price generally but purely on qualifications. The price usually is already set at a certain level or is to be determined during the design phase of the project.

Matt:
And before moving too far along. We talked about qualifications a lot there. I was wondering if you could speak to some of the qualifications that we looked at during this bidding process.

Peter:
So as far as qualifications are concerned, a lot of bid packages will outline a minimum level of experience or specific licensing requirements, bonding requirements or potentially some organizations will also require a past proven record recommendation letters. Usually, those are things that factor into or can be set as minimum qualifications for a bid to be considered.

Matt:
Great.

Peter:
Okay. All right next I wanted to touch briefly on design responsibility and the reason that I wanted to touch on this is it’s very important to understand what level of design responsibility is being called for when deciding to pursue a bid. Design responsibility is generally broken into three different types. There’s a design-bid-build and that’s kind of your standard type of project where the project is designed by the owner or somebody retained by the owner and when you’re bidding the project there’s already a set a plans and obviously you can pay careful attention to the plans in making it bid.

Peter:
The next type is just design-build. Under this type of project you’d be responsible not only to build the project but also to participate in the design of that project. This is a riskier form of bidding because the design hasn’t been outlined yet and you’re responsible for coming up with that design, estimating the cost to do that and proceed to build the project. Sometimes there’ll be multiple stages of bidding here and as far as protecting payment rights, it’s just important to make sure you have a good understanding between you and the owner or higher tier contractor regarding what you are undertaking as far as the scope of work.

Peter:
Two other types of projects that are common are, as I previously mentioned earlier, the integrated project delivery system. Under that type of project, you’re going to have design responsibility, but you’re going to share that responsibility with the prime contractor, the owner, and potentially somebody else given responsibility for design. The final one is public private partnerships. This is a type of project usually done on longer term projects such as highways or sewers that are ongoing. In this case, you’re going to be responsible, most likely for a portion of the design, but it will also be shared with the public owner.

Peter:
Okay. The other probably single most important thing to pay attention to when preparing to bid a project is the bid documents, and I’m going to go through the documents that are generally in a public works bid because that type of bid usually is the most document intensive. The first document that you want to look at is of course the bid invitation, also referred to as a request for proposals. This document will usually contain general information on the scope of work, the bidding process, contact information and probably most important the pertinent dates, deadlines for the bid when the project supposed to begin and the duration.

Peter:
The next document that you need to look at is the instructions for bidders. This is a roadmap for the bidding process and will outline the rules, qualifications and requirements for the bid. Understanding and complying with the instructions are imperative for ensuring that your bid will be considered and also for basically properly understanding what you are bidding for. The next part of the package will be the bid forms. These are generally templates that you fill in. This is where you’ll put in your information specific to your bid. That’s going to be price, the information on you, your backgrounds, potentially any required bond information or anything else required in the bid. Most projects that require payment bonds, which is going to be the majority of public projects, they’re also going to require a bid bond. It’s important to look in the bid instructions or sometimes there’s a separate document outlining what is required as far as a bid bond. And it’s important to secure the bid bond if required because your bid most certainly won’t even be considered if you don’t secure a required bid bond.

Peter:
Finally, if the project is public works, it’s going to contain the contract and general and special conditions in the bid packets. This is because these aren’t really negotiable for a public works bid. This is very important to look through both the contract in general and special conditions when preparing a bid because ultimately this is what you’re agreeing to. And as far as protecting payment rights and understanding the rights that you’re going to have during this project, they’re going to be governed by these documents and you want to have a thorough understanding of these documents before submitting a bid.

Peter:
Finally, if this is a design-bid-build project, the plans and specifications are also going to be included in the bid package. You’re going to need to pay careful attention to these in preparing your bid obviously. And it is also worth mentioning that under this scenario because the owner is undertaking the design responsibility, any changes in the work or even errors in the plans are going to be the owner’s responsibility. And as long as you follow those plans and specifications, you’re entitled to payment for any extra work that is performed.

Peter:
Okay, so now let’s go into a little bit about avoiding payment issues specifically from day one. So one of the best ways to avoid payment issues from the get go is to ensure that your bid is accurate and is going to make you money. The best way to do that is to properly calculate mark-up. So I’m going to go over one of the best ways to, obviously there are many ways to calculate mark-up but I’m going to go up a standard way to calculate mark-up to ensure that your projects are profitable. And I’ll switch here to an Excel document to go over that. And so now you should be able to see a Excel document on the screen. Is that sharing correctly?

Matt:
Yeah, it looks great.

Peter:
Okay. Okay. So generally what we recommend is calculating mark-up based on what’s called the uniform mark-up at least to start. Especially when you’re starting on a new year, it’s a good idea to run this calculation for all your jobs or basically to run this calculation so you have a universal mark-up on which you can base your goal mark-up for jobs and to evaluate jobs.

Peter:
The first figure you’re going to need to do this is last year’s revenue. If you don’t have a full year of revenue, you’ll have to estimate that, but you’re going to need a figure basically for all of the money you collected in the previous year or estimate you would have collected a previous year before factoring in costs. Next you’re going to want to estimate your revenue for the current year and in this example we’re saying that the last year’s revenue was $1 million and we’re being pretty optimistic. We’re going to have a 25% increase this year and I’ll make 1.2 5 million.

Peter:
Next, you also need to decide on what is your profit goal for the year, what percentage of revenue do you want to actually equal profit for your business? And then under this example we’re setting 10% but what’s realistic for you is going to depend obviously on your history and how your business works. Finally, the next figures we’re going to need to do this calculation is overhead. And overhead is going to be all of your costs that are not specifically attributable to any job and that’s broken down into two different categories. Fixed overhead and variable overhead.

Peter:
Fixed overhead is going to be items like rent, utilities, payments for your license, things that are absolutely fixed for the year and again, the best way to come up with that number is going to be what were these costs last year. Variable overhead is going to be composed of items that are variable depending on the volume of projects you have, but still not specifically attributable to any specific job. So this could be equipment, things like fuel, project oversight for people that are on multiple projects, things like that. And again, the best way to get that number is going to be to look at what was your variable overhead for the previous year or what do you estimate it would have been.

Peter:
Next in order to arrive at a uniform mark-up, what we’re going to do is we’re going to take our fixed overhead from the previous year and then we’re going to take our variable overhead from a previous year and figure out what percentage of our revenue from last year that was. In this case, because we’ve said our variable overhead was $100000, basically that’s 10% of our estimated revenue for the last year. Because we are now estimating that our revenue is going to be at 1.25 million, that 10% is going to allow us to calculate our variable overhead for the current year and as 125000. So that’s the number we’re going to use to calculate our mark-up for the current year.

Peter:
But the final thing that we need to calculate is our net profit or estimated net profit for this year and that’s going to be calculated based upon our profit goal, which is 10%, multiplied by our estimated revenue, which is going to be the 1.25 million in this case. So we’re also going to have 125000 for our estimated net profit. So what you do then is you’re going to combine your fixed overhead, variable overhead and net profit to arrive at what’s called your overhead and profit. And in this case we’re getting 350000.

Peter:
Finally, you’re going to subtract your overhead and net profit from your estimated revenue, which was 1.25 To get your total job cost, which is going to be 900000 in this case. So basically what we’ve done is we’ve determined that our overhead is a certain amount and we expect a certain amount of profit, in this case 10%, having done that, the rest of our revenue can be attributed to the actual cost of the jobs that we’re doing. And then if we take the estimated revenue and divide it by our estimated job cost, we’re going to end up with our uniform mark-up. So in this case, it’s going to be an aggregate uniform mark-up of 39% is what we’re going to need to earn our estimated profit goal of 10%.

Peter:
Now for most contractors, this uniform mark-up isn’t going to do a whole lot of good because they’re going to mark-up different categories of their contract, different amounts. For example, generally you mark-up labor a lot more than you mark-up material costs and probably mark-up material costs even more than you mark-up subcontracted work because they have their own mark-ups obviously. To account for that, what we use is called differential mark-up. And basically under differential mark-up, we can take our categories, our various categories that we’re going to mark-up differently. In this case, we’ve got estimated labor costs, material costs and subcontract work. Basically determine how much money we expect to spend in cost, what proportional cost we expect to be in that category, and then choose a mark-up specifically for that category of work.

Peter:
So in this example, which is for the whole year, we’re assuming that labor costs are going to consist of $250000 and we’re going to mark that up 100% so we’re going to bring in 500000 on that. Material costs are going to be 400000, we’re going to mark that up 20% and subcontract work is going to be 250000 marked up 8%. And it just so happens that under this scenario we’re going to end up with the same uniform mark-up as we calculated, which is going to be approximately 39%. So we know that using these mark-ups for these separate categories, we’re going to end up with a uniform mark-up of 39% which we can expect to deliver us our profit goal of 10%.

Peter:
Now this is more useful when applied to specific projects or bidding because what you can do is you can add up your proposed elements of costs and then determine exactly what mark-up’s going to be required to meet your uniform mark-up. And that’s going to tell you whether or not the mark-ups you previously determined this job is going to be profitable or not. In this example here we have $12000 of labor, $50000 in material costs and $26000 in subcontractor work for this hypothetical job. But as you can see the mark-ups need to be higher for us to arrive at a uniform mark-up of 39%. What that tells us is maybe we can get away with marking up this work more on this job, but if not, this might not be a profitable job at least based on the underlying costs that we’ve outlined here.

Peter:
Finally, if you’re a contractor that relies primarily on labor and labor is your main cost, you can also do what’s called a labor mark-up. And under a labor mark-up basically we can take that previously calculated overhead and profit, in this case that was 350000 and we can take the total estimated hours that we are estimating to use for the year, assuming that labor is going to be our primary cost. And by dividing the overhead and profit by the hours, what that’s going to tell us is what mark-up we need on wages to achieve our profit goals. In this case we’re going to need $23.33 on top of whatever wage we’re paying to basically pay for the cost of our overhead and the cost our profit, which is 10%, so that’s what we’re going to need to be successful.

Matt:
That’s a really helpful tool. And we’re getting a lot of questions about… Are you able to scroll to the side maybe and show some further columns? I think it’s getting cut off about column E.

Peter:
Column eight. Let’s see. So we got A, B, what column?

Matt:
It looks like it’s getting cut off after column E on the display.

Peter:
Okay, so if I zoom out here, does that help?

Matt:
It doesn’t seem to be right now, but what we can do is-

Peter:
So basically what… I can just cut and paste it over. But in the other columns we just have…

Matt:
And also we’ve mentioned, so we will be able to share some of this content afterwards too, to make sure that everybody gets the most use out of it and…

Peter:
Okay. Okay. So what is in the other columns, is basically just a statement of the mark-up earned. So basically what that is, it’s going to be our estimated revenue minus our overhead and profit. So that’s going to show the mark-up earned. And then after that there’s just simply the percentage of the mark-up. So in this case, approximately 39%.

Matt:
Cool. Sounds like we got that down.

Peter:
Let me share the PowerPoint again. Is the PowerPoint back up?

Matt:
Yep.

Peter:
Okay. Finally, in addition to mark-up, I wanted to talk about managing slow payment and the cost of delay from the bidding standpoint. And on public projects, this is going to be more difficult because there’s already going to be a lot of strict parameters. But you have a lot more latitude, especially on private projects, especially on small projects, regarding what you include in your bid to basically manage expectations and define the relationship. And define what’s going to be happening if payments aren’t paid on time and also how extra work that is not your fault is going to be factored in to change orders to get you paid more. And this can help prevent payment disputes and it can also basically set the expectations from the beginning, making it clear to the owner that if they accept your bid, they better not screw around with payment.

Peter:
The first thing that you should consider including in your bid is a timetable unless there’s already a project timetable clearly set forth in the project. And the reason to do this is you’re setting out a bid and it’s based on current costs or at least your estimate of what costs are going to be when you start this project. But if they delay substantially in starting the project, you need to be able to go back and say, “Wait a second. Yes we were ready, willing and able to perform this work at the bid amount when we first submitted our bid, but that was based on starting on a certain date, completing on a certain date and by the way that new time table might conflict with other work that we have bid.” So to the extent you can, it makes sense to state in your bid that this bid is contingent on starting work on a certain date of being able to work continuously for a certain period and that the bid will be subject to price increases and scheduling issues pending scheduling with other projects, if that timetable is not met.

Peter:
Another thing that you might want to include specifically or specifically set out in your bid is the cost of mobilization/ cleanup or demobilization. The reason for this is some projects might require you to mobilize multiple times and you should specifically set that out in your bid and it could be that because of a design issue, weather or some other reason, not your fault, you’re forced to mobilize multiple times. In that case you have a right to demand additional payment for those additional mobilizations, but that’s going to be a lot easier to do and you’re much less likely to get pushback if the cost of mobilization is clearly set forth in your bid.

Peter:
Finally, another thing that you can include in there is payment terms. So I mean as a general matter, a lot of projects are paid net 30 or net 15. But whatever you expect to be for your payment terms, you should set that forth in your bid so that the owner or higher tier contractor in accepting your bid understands what the expectations are for payment. It’s true that there are prompt payment penalties and other things that govern payment deadlines, but it’s much better if you just set forth those deadlines in your bid and then also in your corresponding contract because that’s going to manage expectations as well as give you something clear to point to you in your agreement if payment’s not made on time.

Peter:
Another thing you may be able to include is a provision for what’s going to occur when there’s late payments. Again, under prompt payment laws, which vary by state, there are certain interest payments that you’re entitled to, but it’s better if these are just set forth in the bid, in the contract. So everybody understands that if they make payment late, they’re going to be subject to certain penalties or interest payments. This is another good way to deter a higher tier contractor or a owner from even considering making payments late from the get go. This is going to be easier if you’re a prime contractor because the owner has more control. If you’re a lower tier subcontractor, it’s less likely you’re going to be able to get them to agree to this because obviously they’re not going to want to have to pay you until they’re paid and they can only control that to an extent. But they may have similar provisions in their contract with the owner under which case they might be more willing to accept that type of term but it never hurts to include in the proposal if it can be negotiated.

Matt:
Absolutely. Couldn’t agree more. And it’s a great point about mobilization and demobilization costs. That’s something that all too often gets thrown a little bit by the wayside and that are absolutely cost that will eat into your profit.

Peter:
Okay, so basically the main moral of the story here is you want to earn the work, but you also want to manage expectations for what’s going to happen when the project begins and how payments are going to be made when they should be made and what the consequences are of not making those payments. And the bid is your first opportunity to do that. I think we’re already out of most time here. So I think I’ll stop there.

Matt:
Yeah, I appreciate it. Sorry, I was just about to hit the warning. Thank you so much for your time. I know, I really appreciated it and I got a lot out of it and I’m looking forward to seeing more of your contributions to the expert center.