All construction and infrastructure projects present enhanced reputational and financial risks to owners and developers (referred to here collectively as “owners”). In a typical large project, owners commit hundreds of millions—if not billions—of dollars to a contractor, often with little understanding of the contractor’s risk management strategies.
In many instances, keeping the construction work within the proposed budget and on schedule are the primary areas of concern for the owner, and they may overlook the contractor’s control framework to manage financial, reputational, operational and regulatory risks. While obviously important, budget and schedule should not be the only driving factors in engaging a contractor; ignoring other risks can come at great cost to the owner. Examples are many and varied and include:
In a survey conducted by PWC with construction and engineering firms in the US, 49% of respondents said they had encountered at least one form of bribery or corruption, the highest percentage of any industry. In addition, 70% of the most serious economic crimes in the construction industry were committed by internal perpetrators and, surprisingly, less than 50% of the construction and engineering respondents reported performing fraud risk assessments annually, leaving their clients at risk.
A recent review of US Department of Justice (DOJ) press releases identified over 50 instances of the DOJ bringing charges against individuals or firms relating to construction in 2022. The charges included bid-rigging, money laundering, fraud, corruption and tax evasion, among others.
Some owners might think that such issues are not their concern, but this is misguided. It only takes one contractor to sully the owner’s reputation or create issues on a job site that could lead to operational risk such as shutting down the job, the need to replace a subcontractor or financial loss.
Two examples:
- In March 2022, seven South Korea-based construction and engineering companies agreed to pay USD 3.1 million to resolve allegations that they violated the False Claims Act by engaging in a bid-rigging conspiracy that targeted US Army Corps of Engineers (USACE) contracts on US military bases. According to the DOJ, the companies conspired to suppress and eliminate competition during the bidding process on 15 USACE contracts awarded between 2016 and 2019, which resulted in the USACE paying substantially more for services performed under the contracts than it would have had there been competition among the bidders.
- Two US construction companies pleaded guilty in federal court in Connecticut in August 2022 for their roles in a conspiracy to rig bids on insulation contracts and engage in criminal fraud related to those contracts. According to the DOJ, for almost seven years the companies conspired among themselves and with other companies and individuals to rig bids on contracts for installing insulation around pipes and ducts on construction projects at universities, hospitals and other public and private entities.
In addition, contractors and their subcontractors are well known to take advantage of owners, consciously or not, through overbilling in change orders, insufficiently supported billings and other schemes leading to financial loss to the owner. For example, in November 2022, an Ohio-based construction company agreed to pay USD 302,500 to resolve allegations that it violated the False Claims Act by issuing false and fraudulent invoices for non-existent materials to the US Department of Energy (DOE) and paying improper kickbacks. The DOJ alleged that a subcontractor knowingly submitted to the prime contractor hundreds of invoices charging millions of dollars for materials that did not exist.
What to do as an owner developing real estate and infrastructure
One vital question all owners should ask while undertaking construction projects is what are the risk mitigation strategies employed by the general contractor/construction manager? Owners should consider reviewing the contractor’s control framework by performing a risk assessment to identify control gaps and implement a program to address the identified gaps.
An effective control framework to mitigate construction-related risks should include (1) third-party due diligence; (2) procurement reviews; (3) detailed reviews of change orders, allowance or contingency billings; (4) a robust compliance program; and (5) fraud and corruption mitigation strategies.
This is the first article in a planned series to discuss the risk mitigation strategies listed above, including strategies that owners can take to limit risks, provide a better managed project and flag potential overbilling and identify cost avoidance opportunities.