Preventing Disaster if the Renovator Goes Bankrupt

Recently, there have been reports about a renovation building contractor who ran into financial difficulty and has left as many as 15 families in a mess with partially completed projects.

This article is too late for them, but it might help someone else who is planning a major project.

According to an article in the Toronto Star, the contractor:

“… blamed his “own pride and arrogance” for what he said was a fatal decision to expand too rapidly.

“My pride prevented me from realizing I was not able to manage this company on my own, and I convinced myself, and those around me, that everything was fine,… unfortunately, over the last year, that has not been the case.”

The name of the contractor, the names of the homeowners and their specific projects are not as important as the solution.

With 20 projects “on the go” this contractor was both successful and busy. What did he actually have going for him?:

  • A portfolio of successful projects
  • Good references
  • Quality work
  • Good sub-trades
  • Member of a recognized and well-known contractor’s association
  • Excellent reviews and evaluations on an independent and popular website

So, what can a potential homeowner do? Everyone says: ”check references…get referrals….. see the quality of the work etc…”. But, here, all that checked out!

When the dust finally settles in this case, I suspect it will be financial mismanagement and the failure to run the business properly. That will be the core of the problem.

So, what happens? A good contractor, Harry will hire Andy, Bill and Charlie to help him build and renovate. They are experienced and they are good. They show up on time and their work is flawless. No one ever has to come back and clean up after them or redo something that they have done.

Harry uses his first successful project as his calling card to get more business. This time he has two projects on the go. Andy, Bill and Charlie work on one and he hires Dave, Ernie and Frank for the second one. So far, so good. The first project gets done well, and on time. Andy, Bill and Charlie actually come over and help out by finishing up the second project. Now, you see where this is going!

The second project is finished on time, and the third one, quality work but slightly delayed. In the construction business, “time is money”.

Harry, now with good references and three successful projects under his belt is ready to take on the world. These three successful projects comprise his portfolio. His past clients love him and his sub-trades are happy.

Next Go Round: Harry takes on three more projects. Andy, Bill and Charlie work on the first one. They are the “A” team. They get their house, “in, done and finished”. Dave, Ernie and Frank work on another. They still need a little help finishing things off, but it gets done.

Here’s the problem, Harry hires Gord, Henry and Ivan for the third house. He doesn’t know them. They are inexperienced, new and incompetent. They are nice and well-meaning, just inept. They get paid as time goes by.  Andy, Bill and Charlie from the “A” team, Dave, Ernie and Frank from the “B” team all come over to help finish off that third project. Here’s the crunch: Andy, Bill, Charlie, Dave, Ernie, Frank, Gord, Henry and Ivan all need to be paid out of that third project and there’s no money.

What does Harry do? No problem, Mark and his wife Mary just agreed to have their house renovated. It will cost $275,000 and they just paid a $50,000 deposit. I know, you thought that money should go to building materials that were required for the Mark and Mary project. Well, all things being equal, they would have, but these funds were necessary to finish off project #6 and keep everyone happy. On project #6 everyone made money except Harry. The homeowner there ended up with a good quality house, long delayed and a pile of excuses. Going forward, that particular homeowner might not make the best reference.

You will appreciate that this takes place all the time. Well-intentioned people take on more business than they can truly handle. The business moves away from building which was Harry’s expertise to managing people which he really knows nothing about.

At the end of the Mark and Mary project, there will be $50,000 short. This might mean any one or more of the following:

  • Some extras and unexpected events will cost $50,000 more
  • Harry won’t make any profit on the job
  • The $100,000 deposit from Rick and Sylvia could be used

Eventually, this entire approach to running a business will come crashing down.

If the shoe drops on the Mark and Mary project, here’s what can happen:

  • The project will be delayed
  • They have already paid too much money for the work that was done
  • Other contractor’s will charge considerably more for completion
  • The warranty or guarantee will cost extra or won’t apply
  • They likely didn’t maintain a construction lien holdback
  • They will have to pay again another 10% of the price they already paid the contractor
  • If there was a specific notice of a claim, they will have to pay that too
  • A lawsuit for recovery of losses will be expensive

How do we solve this problem?

SOLUTION

Ok, I already know that Harry won’t like it, but he will still likely go along with it.

Mark and Mary go to their own bank and open up a two separate accounts. The first is the general construction account. It will require the signatures of ONE of Mark and Mary, plus Harry. The second account is the lien account. Just Mark and Mary are signatories here. If $10,000 worth of work is done, then there is $10,000 to be paid over. Harry can draw up the cheque but he needs either Mark or Mary to sign it too. Next, the first cheque is for $9,000 and an additional $1,000 cheque gets paid over to the lien account. This is the amount of money that Mark and Mary are obliged to hold in trust under the Construction Act. Every building contract in Ontario is deemed to be amended to include this holdback requirement.

And so, the project continues. Mark and Mary are satisfied with the renovations. They co-sign the last cheque and 46 days later, they write a cheque for the balance of the funds in the lien account. Both accounts at the bank are then closed.

Now, everyone is happy. Harry gets paid, the sub-trades get paid and Mark and Mary have a successful renovation project. SIMPLE. But, as you know, it just doesn’t happen.

By the way, what do the big guys do? Well, on all the big construction projects, there’s a performance bond requirement. The contractor obtains the bond from an insurance company which guarantees performance of the construction project. That’s even better than the separate bank accounts.

There are a few other matters to consider:

  • Get a good contract
  • See the invoices before payment
  • Observe the lien provisions
  • Agree on third party arbitration, if there is a dispute
  • Get original warranties on all the equipment, and fixtures installed

It’s always best top consult with a good lawyer to assist in drafting up the contract. A good Solicitor now, will save you fees, so that you don’t have to retain a Barrister later.

Brian Madigan LL.B., Broker

www.OntarioRealEstateSource.com

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