Construction Contractor or Consultant?

Change is inevitable, even in the construction industry. One of those changes is construction consulting, sometimes called CM (construction management) consulting – or CM for short.

Veteran builders will remember a time when residential contractors did most framing and finishing with their own crews. Today, a residential contractor with payroll is the exception. Most let subs handle nearly all work.

CM consulting takes this trend one step beyond. A CM contractor is a consultant to the owner, pure and simple. No subcontractors. No payroll. No payroll taxes. No risk. The CM recruits contractors and subs, schedules the work, orders materials, supervises the job and tells the owner when it’s time to pay bills. But all decisions and contracts are in the name of the owner. Simple and easy.

Now the Hard Part

Is a CM consultant a “contractor” for licensing and contracting purposes? Only a few states have decided the issue. Washington D.C. Code of Municipal Regulations § 17-3905.1 to § 17-3905.14 requires that CM consultants comply with standards set for general contractors. Tennessee (Lowrey v. Tritan Group Ltd., 2009 U.S. Dist. LEXIS 60312) and New York (Liberty Management & Construction v. Wasserman, 1996 U.S. Dist. LEXIS 4408) are the same. In nearly all other states, whether a CM consultant is a contractor is anybody’s guess. So if there’s no answer, you might ask, “Why should I care?”

Here’s why. Where contractors are licensed, an unlicensed contractor has no right to collect. So a CM with no contracting license might not be able to collect. That gets the attention of anyone working as a CM. But it’s only the beginning. A consultant needs only an employment contract – or no written contract at all. If your state considers CM consultants to be contractors, every CM agreement has to include the notices and disclosures required in construction contacts – up to 18 pages of fine print in some states. Without those notices and disclosures, the CM contract is probably void.

Maybe you’re beginning to understand the problem. Use the CM loophole and you risk getting pinched if the loophole closes without warning.

States have an interest here. They’re not going to let the increasing popularity of CM consulting knock state regulation of contractors into a cocked hat. California is an example. A March 2009 appellate decision (172 Cal. App. 4th 939) allowed CM consultant Fifth Day to collect from Bolotin like any contractor even though Fifth Day did not have a contracting license. To stop an end-run around licensing law, the California legislature clawed back. Last month, Governor Jerry Brown approved a revision of California Business and Professions Code § 7026. The law goes into effect on January 1, 2013. The new definition of “contractor” includes what every CM consultant does:

(A) Provides or oversees a bid for a construction project.

(B) Arranges for and sets up work schedules for contractors and subcontractors and maintains oversight of a construction project.

That settles it, at least in California and at least for home improvement work. Starting January 1, 2013, CM consultants in California need a contracting license and have to work under a legal construction contract. Expect other states to fall into line one by one.

Protect Yourself

The AIA and CMAA publish model CM contracts. Neither includes the notices and disclosures required by state and federal law. That makes these model contracts illegal for most jobs in most states. Construction Contract Writer drafts CM contracts that comply with both federal law and the law in your state, regardless of the type of construction – residential, commercial or home improvement.

 

Employee or Subcontractor?

Every contractor understands the advantage of getting work done with subs rather than employees. Employees come with headaches like payroll taxes (F.I.C.A., F.U.T.A., S.U.I), employee insurance, fringe benefits and overtime. Collectively, those add about one-third to labor cost. With subcontractors, you simply write a check payable to the sub. No withholding tax. No fringe benefits. No overtime.

So why would any contractor have employees?

The simple answer is that many don’t. That’s known as paper contracting. For details, see my blog post.

But there’s another reason, usually referred to as employee classification. States and the I.R.S. have rules about who qualifies as a sub (an independent contractor) and who has to be paid as an employee.

What makes a sub?

Simply labeling someone a subcontractor doesn’t work. In fact, no single test settles the matter. States and the I.R.S. apply their own rules. But all would agree that most employees:

• Work under employer control and can be laid off.
• Comply with work hours and the sequence of work set by the employer.
• Can’t substitute someone else to do the work.
• Are paid by the hour, week or month rather than by the job.
• Use the employer’s tools and get reimbursed for expenses.

Subcontractors are in business for themselves. They:

• Promote their services and have a business address.
• Usually work under contract for several prime contractors.
• Work for a contract price and cover their own job expenses.
• Have to redo unsatisfactory work at their own expense.
• Stand to make a profit or suffer a loss on the job.

What’s the risk of misclassification?
Make a mistake about who’s a sub and who isn’t and you could get hit from two directions. The employee could file I.R.S. Form 8919 to collect unpaid Social Security and Medicare Tax on wages. Then your state and the I.R.S. could claim a tax lien for failure to withhold. The I.R.S. can be a pit bull when collecting delinquent payroll tax – including seizure of personal assets.

If you’re concerned that subs on your jobs could be classified as employees, here’s a case in point.

Bernie Kurio had worked for several years as a Houston drywall contractor before he got caught up in an I.R.S. sweep. An audit of Bernie’s books resulted in an assessment of $89,063 for failure to withhold payroll taxes. Bernie’s protest of the assessment was denied by the I.R.S. regional commissioner. But that wasn’t where it ended.

Bernie appealed to U.S. District court. Surprise! He won. The tax lien was discharged. The court’s decision makes good reading for every contractor concerned about employee classification. Here are the facts that won the case.

When Bernie landed a drywall job, he called several hanger team leaders. The team with the best price per square foot got the work. Hangers, tapers, floaters, sanders and truckers used their own tools and equipment. Bernie controlled only the result, not the hours or who did the work. Drywall crews understood they were independent contractors and – here’s the key point – most reported earnings on their Schedule C.

Bernie’s case, Kurio v. United States, dates from 1970 and has been followed ever since. Stay within the facts of the Kurio decision and you should have no trouble with either state or federal authorities.

Use written subcontracts to end any debate about employee classification:

• Payment will be by the job.
• You control only the finished product.
• Subs are responsible for their own taxes.

Construction Contract Writer makes that easy. The trial version is free.

Time and Material Construction Contracts

Many contractors prefer time and material (cost-plus) contracts. And for good reason. With T&M, you’re sure to recover expenses and earn a profit. There’s no dispute about the cost of changes. Work can start before design is complete. The job gets done just the way the owner wants – and at the owner’s expense. What could be better?

I agree. But it’s not automatic. You’re headed for trouble on any T&M job if the contract isn’t airtight. Some signs of trouble:

I didn’t agree to pay for that. Most disputes on a T&M job will be about labor cost. For example, does the contract set a specific hourly rate for each trade? If not, does the charge for time include all taxes, insurance and benefits? What about overtime? Are there limits on pay rates? Is it legitimate to charge for non-productive labor (supervision)? Or does non-productive labor have to come out of OH&P? What’s the charge for contractor-owned tools and equipment?

How do I know these charges are right? Few owners will be satisfied with a simple expense summary. Most want to see copies of invoices, receipts, cancelled checks and pay ledgers. Some will insist on the right to audit your books – and may decline charges that aren’t fully documented. No contractor feels comfortable in that position.

Why charge me for your mistakes? The owner’s cost will be higher when work doesn’t pass inspection, has to be torn out or repaired. Few owners are eager to cover expenses like that. None want to pay for what they consider pure negligence.

Your OH&P seems excessive. The charge for overhead and profit can be a lump sum or a percentage of total cost. If OH&P is a set sum per week or month, the owner won’t see a reason to pay if the job sits idle for weeks. If OH&P is a lump sum for the job, a contractor takes a hit when the job runs behind schedule. If OH&P is a percentage of job cost, a careful owner will scour every labor and material charge for padded expenses that inflate your net.

Are you sure this was really necessary? Owners don’t understand construction the way a contractor does. You’re on the hot seat if an owner wants a full explanation of everything that seems out of line.

T&M contracts are illegal for home improvement work in six states. See my blog of July 2010 for legal ways around this restriction.

A good contract can avoid nearly all the likely sticking points in a T&M contract. For example, to settle the “Was that really necessary?” question, define “reasonably necessary” very precisely in the contract. Then point to that definition when you sense “really necessary?” is about to become an issue.

Three more points on T&M jobs:

1. An owner and a contractor remain potential adversaries. Only the context for disputes has changed.

2. Nearly all the likely disputes on a T&M job can be resolved with a good contract.
3. The best tool for drafting T&M contracts is Construction Contract Writer. The trial version is free.

Construction Contract Law Gibberish

The law in most states puts residential contractors at a disadvantage. Omit a required notice or disclosure and your contract is probably unenforceable (at best) and could earn you a fine (or worse). That’s called consumer protection law. No use complaining. It’s not going away.

To help protect consumers, several states require that contracts be written in plain English. Among these, my favorite is Connecticut’s objective test of understandability. By law, every consumer contract in Connecticut:

(1) Has to average less than twenty-two words per sentence.

(2) Can’t have any sentence with more than fifty words.
(3) Can’t average more than seventy-five words per paragraph.
(4) Can’t average more than 1.55 syllables per word.
 

OK. So if construction contracts have to be easy to understand, shouldn’t construction contract law also be easy to understand? That makes perfect sense to me. It’s a two-way street. Contractors shouldn’t have to guess at what the law requires. Lawyers shouldn’t have to apologize to clients about gibberish in the law. If a legislature really wants contractors to comply with the law, shouldn’t they make the law easy to understand?

Case In Point

Last week a California contractor asked me a simple question: “Nearly all my jobs are for home owner associations. Do my agreements with HOAs have to include all the notices and disclosures required in California home improvement contracts?”
 

That’s easy, I thought. A HOA isn’t a consumer in the classic sense. Consumer protection law shouldn’t apply. But just to be sure, I looked up the law before answering. Here’s what I found.

 

California Business and Professions Code § 7159 prescribes the 18 notices and disclosures required in home improvement contracts. But § 7159 refers to § 7151.2 for the definition of “home improvement contract:”

 

"Home improvement contract" means an agreement, whether oral or written, or contained in one or more documents, between a contractor and an owner or between a contractor and a tenant, regardless of the number of residence or dwelling units contained in the building in which the tenant resides, if the work is to be performed in, to, or upon the residence or dwelling unit of the tenant, for the performance of a home improvement as defined in California Business & Professions Code § 7151, and includes all labor, services, and materials to be furnished and performed thereunder.”

 

Read those words any way you want. I don’t believe they answer the contractor’s question, “Is an agreement with a HOA a home improvement contract?” No California court has interpreted § 7151.2 and nothing on the State License Board web site helps define “home improvement contract”. So we’re left to guess.

 

Here’s my best guess. Insert the words “of the owner” after “upon the residence.” That would make it clear. It’s home improvement only if work is done on the residence of the owner. That makes sense. Consumer protection law protects consumers, not a business entity such as a HOA. As amended, work done for a HOA would not be home improvement.

 

Here’s My Point

As written, § 7151.2 doesn’t answer a simple question. That’s bad. Even worse, California § 7151.2 is far from plain English, at least as Connecticut sees it. No sentence can have more than 50 words. Section 7151.2 weighs in at 95.
 

My recommendation: If you want to comply with state law but aren’t eager to parse the fine points, rely on Construction Contract Writer to keep you legal. The trial version is free.

Waiving the 3-Day Right to Cancel

Every residential contractor knows about an owner's 3-day right to cancel, sometimes called the Reg Z notice. Any time you do work on the principal residence of an owner (whether new construction, improvement or repair) you have to:

• Give each owner two copies of the notice.
• Show on each form the date the right to cancel expires.
• Wait three days (excluding Sunday and holidays) before starting work.

My blog of February 2010 described how vicious this little form can be. Make a mistake and the owner has three years to cancel – and get a full refund! Imagine making a refund on a job you finished nearly three years ago.

What I didn’t explain

There are times when beginning work without waiting three days makes perfect sense  – and is in the owner’s best interest. If you do it right, there’s no risk. Here’s what the law (12 CFR § 226.15) allows.

1. The owner has a true personal financial emergency. To me, a financial emergency means that delay is going to make things worse.
2. The owner has to give you a written waiver of the right to cancel. The statement should be handwritten (not a printed form) and has to be dated and signed by everyone with the right to cancel.
3. The statement has to describe the emergency. For example, “My roof blew off and a storm is due later this week.”
4. The statement has to waive the right to rescind. For example, “I give up my right to cancel this contract.”

With that statement in your file, it’s OK to start work right away. But don’t abuse the privilege. Waiving the right to cancel shouldn’t be routine.

Worse still, don’t routinely ask for a post-dated confirmation that the 3-day right to cancel has expired.  That’s likely to be confusing.

Your Turn

The focus of Reg Z is lenders – banks and credit card merchants. But Reg Z affects nearly all residential contractors. It should address the construction context. Specifically, Reg Z allows waiver of the right to cancel only for financial emergencies – not practical emergencies like flood, fire or wind damage.  Storm damage can be an emergency by any standard. But it may not be a financial emergency. The law should be clear. And this is a good time to have your say.

Responsibility for Reg Z has been transferred to the new Consumer Financial Protection Bureau. And the CFPB has asked for public comment on a revision they’re preparing for Reg Z. The comment period ends July 8. If you agree that Reg Z should do a better job of defining what construction contractors need to know, the CFPB want to hear from you. Here’s where you can leave a comment.

Changes in Construction Contract Law

Most state legislatures make their changes to the law effective on either January 1 or July 1 of each year. Here’s a state-by-state summary of major changes to construction contract law taking effect on July 1, 2012:

California – Forty pages of lien laws will change. Civil Code § 8000 to § 9566 will replace Civil Code § 3082 to § 3267. The 40 pages are completely reorganized. Many sections are changed, including some that affect construction contracts. For example, new Civil Code § 8170 changes disclosures required in contracts for non-residential work. If you need a correlation table that relates old lien law section numbers to new section numbers, drop me a note.

Idaho – Idaho Code § 29-110(1) voids anything in a contract which would shorten the statute of limitations.

Indiana – On a residential job at least partially covered by insurance, Indiana Code § 24-5-11-10 requires that the contract include a notice giving an owner the right to cancel if any part of the claim is denied. There’s more on insurance jobs below.

Maryland – Business Regulation Code § 8-501 requires new disclosures in home improvement contracts.

Tennessee – On July 1, Tennessee code will create four new hurdles for construction contractors:

§ 66-34-103 and § 66-34-104 change retention rules on both private and public contracts.
§ 47-18-104(b) creates additional requirements for home improvement contracts.

§ 39-14-154(b) adds to the list of prohibited acts by home improvement contractors.

§ 62-6-601 to § 62-6-606 require that residential roofing contracts covered at least in part by insurance include a notice of the right to cancel if any part of the claim is denied.

Most of these changes come with heavy penalties for non-compliance. For example, Tennessee § 62-6-606 makes omission of the new right to cancel notice “a deceptive act or practice” under TN consumer protection law and gives owners a private right of enforcement.

Insurance Jobs

On July 1, 2012, Indiana and Tennessee become the second and third states to join Illinois in giving owners the right to cancel a construction contract after an insurance claim is denied. See my blog post of November 28, 2011 for more on the Illinois law. As in Illinois, IN and TN require that multiple copies of a special cancellation form appear in the contract.

The TN law applies only to roofing. Contractors can’t accept a down payment or start work (except for emergency repairs) until the insurance claim has been processed. If any part of the claim is denied, the owner can cancel the entire contract, even for work already completed.

The IN law covers all insured exterior repairs and allows a down payment. If the contractor starts work before the claim is processed, the owner’s right to cancel extends only to the part of the job not covered by insurance. Indiana Code § 24-5-11-10(c)(5). That’s a better outcome for contractors.

If you’re using Construction Contract Writer to stay in compliance with the law in your state, the program will revise automatically when these new laws go into effect. If you’re not using Construction Contract Writer, the trial version is free.

Living with Pennsylvania's HICPA

My March2009 blog suggested that Pennsylvania's Home Improvement Consumer Protection Act (HICPA) didn’t have to be a deal breaker for residential contractors in PA. The law (effective July 1, 2009) was written to tip the playing field in favor of owners when negotiating for home improvement work. But the legislature in Harrisburg didn’t think of everything. There are still good ways for contractors to protect themselves. The March 2009 blog lists seven good ways to cut your risk on Pennsylvania home improvement jobs.

Some of HICPA makes good sense, starting with a requirement for written, professional-grade contracts. A simple handshake isn’t enough. Pennsylvania home improvement contracts have to explain exactly what’s included and what’s excluded. When should work start and when should it be done? When are payments due? There’s a limit on down payments. You have to list subs and their phone numbers. Change orders have to be in writing. I like that. And you should too. The best way to avoid disputes is with a professional-grade contract.

But don’t be confused. Boilerplate contracts sold by the professional trade associations aren’t professional-grade for HICPA purposes. Contracts for home improvement work in Pennsylvania have to be written specifically for Pennsylvania. HICPA makes the entire contract unenforceable by the contractor if any of ten common clauses appear in the document. The poisonous ten includes hold harmless clauses and terms that award attorney fees to a contractor. Clauses like these appear routinely in trade association contracts.

Changes to HICPA

The law was amended in July 2011 to cut big box stores some slack. Major retailers like collecting in full before work starts. The attorney general didn’t consider that when drafting the 2009 law. So the law was changed last July to accommodate big box retailers.

And now a Pennsylvania court has jumped in, interpreting HICPA for the first time. The case is Gelacek v. Lunz, 2012 Pa. Dist. & Cnty. Dec. LEXIS 6. The owner, Dr. Gelacek, refused to make final payment on a room addition to his home on River Road in Freeport, PA, basing his refusal on non-compliance with HICPA. The contractor, Lunz, argued that HICPA doesn’t apply to room addition jobs. Room additions are new construction, reasoned Lunz. Construction of a new home is specifically excluded from coverage under HICPA.

True, the law’s definition of home improvement omits any mention of additions to a home. According to HICPA, home improvement is any “repair, replacement, remodeling, demolition, removal, renovation, installation, alteration, conversion, modernization, improvement, rehabilitation or sandblasting.” Judge Valasek had a different opinion, ruling that HICPA applied and Lunz was out the final payment of $31,559.76.

I see two take-aways from this case. The first is obvious. Room additions are home improvement even though the law doesn’t say so. The second is more subtle. The contractor, Mark Lunz, made a contractor’s worst mistake, agreeing to extras without a written change order. Dr. Gelacek and Lunz had a written contract for $118,805. But Lunz agreed to changes that added $163,495.51 to the job – without any written agreement whatsoever. Lunz felt he had an oral contract for time and materials for the extras. That doesn’t work under HICPA for two reasons. Both oral agreements and cost-plus contracts are illegal for home improvement work in Pennsylvania -- an expensive lesson for Lunz.

A Better Choice

Good HICPA contracts are easy with Construction Contract Writer. Written change order forms are included. CCW even writes cost-plus (GMP) contracts and owner’s representative (consulting) contracts. All comply precisely with Pennsylvania law. The trial version is free.