A Two-Way Ripple Effect: What Happens When a Sub’s Legal Woes Divert Finances
Construction projects, large and small, feature a chain of command: general contractors (GCs) at the top, followed by subcontractors (subs) and then sub-subcontractors. As delegations trickle down from the top tiers, each party may be responsible for the actions of those below them, so any problem at the lower level could potentially trickle upward. This was the case with framing and drywall subcontractor RDV Construction (RDV) in California.
According to a February report in the Los Angeles Times, RDV was hired by several GCs, including Westside Contractors Inc., R.D. Olson, Alpha Construction, Carmel Partners and Regis Contractors, for private mixed-use projects. On Feb. 11, it was widely reported RDV did not pay for nearly $12 million in minimum wages, overtime or rest breaks for more than 1,000 construction workers between 2014 and 2017—described by California's commissioner spokesman Frank Polizzi as "the largest wage theft case in private construction."
The article proceeds with an interview with David Kersh, the executive director of the Carpenters Contractors Cooperation Committee, who told the L.A. Times the state should hold GCs accountable for the actions of subs. To an extent, Chris Ring, of NACM's Secured Transactions Services, agrees.
Violations and penalties like this tend to have a trickle-up and trickle-down effect, Ring said, the latter being the due diligence of the property owners and GCs.
"If you're working with a subcontractor, look at any potential litigation against them before you extend credit," Ring explained. "It's more than just a credit report and understanding how their financials are going. What most credit managers do is look at the financial picture, but they may not look at the legalities the subcontractor is dealing with."
What kind of pending law suits has the sub faced in the past? What suit action are they currently facing? It's also important to take note of the details behind the suit whether it's fraud, not paying workers or not being licensed. Suit actions become public record and those public record filings are relatively easy to obtain if you know where to look.
A ripple effect also impacts additional parties on the lower level such as material suppliers, Ring said. While the sub is confronting their wrongdoings via penalty payments, there may not be money left to pay their material suppliers, i.e., "robbing Peter to pay Paul."
"Fraud really disrupts everything. In [the California] case, the ill-deed was caught," Ring said. "The sub has to pay out the cash and penalties and they still owe money to people below them. The people below them are waiting for their funds, but they may get paid less or not at all. The trickle-down effect could be that the subcontractors have to pay penalties and to offset those penalties, they attempt to not pay or short pay the material suppliers."
Knowing the legal standings of potential GCs, subs or sub-subcontractors is one of the many crucial factors to consider before a business relationship begins.