56. Professional Builder Contracts With Paul Rojas

The construction industry has the largest number of insolvency events and the largest number of disputes. The homeowner is not to go sue the subcontractor. They're going to go sue the builder. You can't put a quote for a contract build today and expect that the cost is going to remain the same in three months time. Prevention is always better than the cure and they'll actually save themselves a lot of not just costs, but a lot of heartache and a lot of effort. The number of times I've seen builders in breach of their own terms conditions because they haven't read their contract. They'll go download a contract off the Internet and they won't read it and they just start signing away.

This is Professional Builder Secrets, the number one podcast to help you grow your building company safely and securely. Brought to you by the association of Professional Builders. Join us every week as we talk to industry experts and your fellow professional builders on everything you need to know to generate more leads, more sales and higher margins while improving the building experience for your clients. Hello and welcome to the Professional Builder Secrets podcast, a podcast by the association of Professional Builders for building company owners, general managers, VPs and emerging leaders. Here we discuss all things running a professional building company from sales, processes, financials, operations and marketing. We have another exciting episode from the Professional Builder Secrets podcast. I'm joined today by Paul Rojas, managing partner at RCR Lawyers. Paul, lovely to have you here today.

Yeah, thank you, Bosco. Thank you for the invite.

Well, Paul, why don't we get into it, Tell us a little bit about what you do and specialize in for our listeners out there.

Yeah, sure. Look, I'm a commercial litigation lawyer, but a large part of my practice is construction. Construction litigation and insolvency and within construction. And given the industry that we're in with, construction industry has the largest number of disputes. Construction litigation is a big factor.

So when you say it has a large number of disputes across all other industries as well, do you find that that's.

Yeah, the industries construction industry has. That industry has the largest number of insolvency events and the large number of disputes simply because you have large projects and various competing interests. You know, you have architects, builders, homeowners, designers, all factoring together for the one contract. And competing interests always resol. And human nature resolves in disputes, which.

Is a very important reason why you need to have a really locked in solid residential builder contract, which we'll get into. But let's start off with what are some of the current Trends and issues that you're seeing affecting residential builders and in turn their contracts that they have in place.

Yeah, sure. Well, this year I would say that as of probably March, April, it has gone. The activity has increased massively in terms of builders. We're getting contacted every day by builders needing amendments to their contracts for cost escalation clauses. And we're also getting contacted by homeowners wanting advice because they have a builder who's trying to push forward for some extra costs. Unfortunately, in the industry that we're in, given the current market conditions, there is a huge increase in supply, materials and labor. And unfortunately, the builders are stuck in that position where they have to either try to push those costs onto the homeowner or wear those costs themselves.

Right. And it puts you guys at a dilemma too, because in both scenarios, you're trying to do the right thing by bulk. Can building contracts be modified?

Yeah, definitely. I mean, most builders these days, they have industry standard contracts which are very good contracts, for example, like Master Builders or HIA. But I would say 80, 85% of those industry standard contracts these days are amended with special conditions. So you tally that contract to suit your business and your and your requirements and protect yourself and your business.

Are builders aware that these contracts can be modified?

Residential builders, most builders these days are aware. I mean, it's very rare that you get a industry standard contract these days which has not got a special condition in there, particularly now with the market conditions. Most of the amendments are cost escalation clauses, which is also like a rise and fall clause or EOT extension of time for Covid, which is, unfortunately, what's happened over the last few years has really caused a lot of builders to have a rethink about their terms, commissions and their projects and how to look after themselves.

Should residential builders go with a higher number than the recommended margin on a contract? You know, what's your thoughts around that?

The whole builder's margin concept? There's no legislative requirements as to how much you can put down. It's more of a contractual negotiation between the homeowner and the builder. For example, like HIA Master Builders, they have a recommendation of 20%. Australian professional builders recommend 25%. That's really comes down to the building, the homeowner negotiating when they're completing the schedule to the contract. If they agree on 25%, it becomes a contractual provision under the contract contracts.

Right now.

Sorry, but conditions 25 is probably, probably more reasonable under the current circumstances.

Right. And I know, I mean for our listeners out there and it's really important to mark the difference. And. And one of the first lessons I learned with the association of Professional Builders is the differences between markup and margin. So the markup is the amount of profit as a percentage of your cost of sales, and the margin is the amount of profit as the percentage of your revenue. And most of the time, these numbers get really misconstrued and people end up different, you know, not knowing the differences between the two. So I believe the standard for the association of Professional Builders, which is, you know, 25% in order to turn a profit, if you're adding a 25% margin, then you need to technically mark up by 33.3%. And APB members do this and really have an issue with their clients when. When it raises its markup, you know, by that 33.3%, it's simply an objection that can be easily recovered. Having said that, I don't think everyone looks at it that way or considers the fact that a markup and a margin isn't the same thing.

No, exactly. Right. You'd be surprised the number of builders who get it wrong. They put down a markup when it should be a margin and vice versa. Really, it's up to the builder to understand their contract provisions and the terms conditions and be able to apply it properly under the contract. Otherwise, you're kind of cutting into your own profit margin, your own bottom line, really. So understanding how to apply the builder's margin and understanding when to apply the markup is very important.

Right. And if you don't have the right markup in place and the cost starts to increase, that's when we're seeing a lot of the problems start to fall into play, isn't it?

Yeah, 100%. And that's. That's standard to have a markup and a builder's margin. But more importantly, now is more than ever is having that. That contractual right to. To bury the cost escalation clause, which is a. Is a whole other concept or other clause on its own. Yeah.

Right. So what are some of the escalation clauses or fees that people need to be aware of in these contracts? Outside of the markup and the margin side of things, is there anything else that they should be aware of?

Well, these days, because as I said before about the market conditions, I mean, I saw a builder the other day and he was telling me that the cost of timber has doubled in Victoria. So, you know, you're signing up a contract and you got. You got your materials and your suppliers. If it's outside the builder's control. For example, they sign a contract today, they want to start the works until six months from now.

Right.

The cost of materials can increase dramatically over the next three, three to six months. So what happens to the build out situation? Are they going to wear those costs of material supplies or they going to have a contractual right in their contract to push those costs onto the homeowner? Right, that's the whole point of the cost escalation clause. If there's been a, the term is if there's been a significant price increase or that you have the contractual right to send a notice the homeowner saying well, under the current situation, the price of for example steel has gone up by x amount of dollars pursuant to the clause, I'm going to exercise my right to increase the cost for the for the price of steel, for examp example.

Right. And that's just to cover the outrageous amount of expenditures that might come out of the supply chain. Because again, no one has control of these things in the country or worldwide as well. Especially with current times.

Right? Yeah, exactly. We've got Covid, you've got wars in various different countries and so forth. The cost of materials is just so volatile at the moment. You can't put a quote for a contract build today and expect that the cost is going to remain the same in three months time.

Right. So why should residential builders pay attention to risk management in today's world? It sounds like all that you do today is really manage that risk consulting with your clients. But why is it so important and why is it a big topic of conversation?

Yeah, well, the thing is, I always say with builders in the construction industry, like their profit margin is quite minimal to start with. They could build a multimillion dollar development, but their profit and their margin is quite low. So ensuring that you can actually maintain that profit, that bottom line is such a very big thing these days was if you don't have that contractual right I said before about the cost of splashing force, for example, you literally have the example of a couple of builders I've been dealing with. If you sign 10 or 15 contracts for the year and they've all increased by 10 or 15% and you can't contractually push those costs to the homeowner, well then the builder's in a very awkward position.

And why do you think the last two months has this has escalated to so much degree? Is it just during just the current times where the scenarios have just hyper increased? What do you think is contributing to you guys getting A lot of phone calls from the builders going, we need help.

Yeah, it's definitely the supply chain situation. So my conditions, the cost of labor is increased and the cost of materials has increased. It's something that it's not going to get any better over the next 12 months or so. It's likely going to get worse. I mean, you probably see the news, there's a lot of construction companies going into liquidation these days. And it's got the point that there's going to be a large increase insolvency in the construction industry by the end of this year. Wow.

And I don't think any builders prepared for that either. So it really comes at a really surprise to them as well. So look, let's talk about some of the risks that builders need to be aware of when it comes to building their residential contracts, residential builder contracts as well. Especially for the listeners out there who are either new to this or need to sort of change their current contracts. What advice do you have for them and what are the things that you want them to look for in their contracts?

Yeah, sure. Well, particularly with builders, it happens so often is that, you know, you get a builder who puts forward a progress claim and then the homeowner doesn't pay. And what does the builder do? They just, they keep continuing with the works. And before you know it, you know, always say to builders, if you have a client that doesn't pay the second progress claim, what makes them. The client's going to pay the fourth one. And by the time they actually make a decision, they've already carried out and their overheads and they spent a lot of money in trying to finish the job. And they still haven't been paid for the next two or three months. And before, you know, it's dragged on for longer than 90 days. And that causes the cash flow in the construction industry. And the cash flow is if the builder can't pay because the homeowner hasn't paid, then the builder can't pay the subcontractor. The subcontractor doesn't pay the wages of the laborers and they can't pay the supplies. And it causes the insolvency eventually. So the biggest thing for builders these days is understand your right under the contract to suspend the works if you're not getting paid.

And when you talk about the payments, you're talking about the milestone payments. Right. So you have different milestones.

Exactly. So you do the first stage issue a progress claim. Having paid under the terms of the contract, you should be issuing your notice to suspend the works and you're contractually legally told to spend the works, get paid and then recommence, don't continue with the works, which is the nine time out of ten is exactly what builders do because they want to finish the job and deal with the issue about payment afterwards.

Right. And for our listeners out there, New Zealand, Canada and USA or the US basically have already had clauses put into place. It's mostly Australia where we're seeing a lot of the challenges right now with the contracts, is that correct?

Yeah, exactly. I mean, this cost escalation clause is a new thing for contracts in Australia. I mean, at this stage it's still, there's no reported decision. So a lot of lawyers are amending these contracts and so forth and a lot of builders are getting advice on them. And it's a matter of ensuring that you do excise your right. But at the same time there needs to be provisions in there so it doesn't look like it's, for example, like a uncommercial clause or if it doesn't look like it's an unfair contract term. So it's a thing that will become more popular over the next 12 months or so. And I imagine, as always, when there are amendments to various contracts or legislative provisions, it's a good year or so before a case comes out about it, whether you know where it's going to be tested in court. So watch the space. Yeah, yeah.

And Paul, do you find that builders, outside of the association of Professional Builders who really are focused on giving this content out there, is this information readily available or do you find that builders end up getting surprised when they come and talk to people like yourself?

We always get two types of builders and unfortunately most builders are the first type that they only ever speak to a lawyer when something really bad has happened. They come to a lawyer when, worst case scenario, there's something is really bad's happening. And I always say to the client is like, had you come and seen me six months ago, we could have been a better position. The other type of client builder is the one who's more proactive and they, they want to sit down with a lawyer, go, okay, well, I've heard some horror stories about friends of mine, colleagues who have had various things happen. How can I protect myself to ensure that doesn't happen to me?

I think there's a saying, you need to have one good barber, one good accountant and one good lawyer. That's what they.

Yeah, well, the thing is what I always see and like, you know, Australian Professional builders attested. This is in your running a business. You run an effective business. You need to have, for example, a good accountant and you need to have a good lawyer. And as you sit down with your accountant every year, do your tax, you should sit down with your lawyer once a year to go through your contract and go through your business. The number of times I see builders who they go and get some contracts prepared and then they don't change those contracts for seven or eight years. And before you know, the businesses tripled, the business has grown in size. They're actually doing different kinds of construction works, different categories. That contract doesn't necessarily apply to them anymore. And legislation changes, as you know as well. So it's the smart thing to do is sit down with your lawyer once a year.

Yep. And that's kind of like a best practice recommendation.

Right.

Just to keep up with your business. What do you do when you're faced with a difficult situation with a client? And I'm sure you have some pot of gold stories and I'm sure listeners would love to hear some examples of what you've seen. How was it dealt with and potentially some wins for the builder as well.

Yeah, sure. I guess between builders and homeowners, the nine out of 10, when there's a dispute, it's about variations. It is always the same that there's always this misconception between the homeowner and the builder as to what is a variation and what is the actual original scope of works under the contract. And for a builder, the more transparency, the more information they can provide to the homeowner about what is covered in a scope of works. And when they want to have a request to vary the contract, they actually do a proper variation notice and understand how it works on the contract. It's going to go a long way for them because otherwise you're, you're having a fight in QCAT or in court dealing with unauthorized variation.

Right. And what do you do? I'll give you a example which, you know, could be a common example here, but a client takes possession off their newly built home and then refuses to pay the balance. Is that a common scenario?

It does happen. It's always, as I said before, like when you have a builder who, you know, if the homeowner's not paying by the, say the second or third progress claim, well, then they're not going to pay by the last one, you know, when these are the final. So that happens more often than not. And the builders right under that situation is simply to terminate the contract. And sue the homeowner for damages. Right. There's actually in both ministry channel contracts, it's a general terms and conditions about early possession taken by the owner, which is a substantial breach of the contract.

Right. Any other common scenarios that happens in contracts that with a client that you need to be aware of for a common story that you've dealt with?

Yeah, Well, a lot happens these days with unfortunately with builders that they, you know, they're licensed and they take the full responsibility of the project itself. And you always get builders who are stuck in situations where they're not getting paid, but then they still have to pay the subcontracts, for example. So it's always very important that the builder ensures that that payment passes through on time. As I was talking about before, the cash flow is such a big thing because as soon as you don't get paid for one progress claim, it causes that domino effect as I always talk about. And you see it a lot these days. And that's what causes companies to go on in the first place. What you'll notice, like I look back seven years ago, it always happens like a cycle. You had like big companies like Bloomberg Construction, you had a couple other ones going on back then. And that causes a ripple of all these other smaller companies going under.

Yeah.

And just had recently probuild go under. A few other big ones like premium go under, which you'll set. That ripple effect will continue for the next six to 12 months.

And you just talked about subcontractors as well. So tell me a little bit about the legal obligations for a residential builder when it comes to those subcontractors as well. Because by the end of the day it's such a moving target too. Right?

Yeah. I mean it's if it unfortunately with the builder, they take all the onus and all the responsibilities. So if there's any defective works which the builder hasn't carried out, the homeowner is not to go sue the subcontractor, they're going to go sue the builder. I mean, they have a contractual right with the builder. So it's very important for the builder they have those subcontracts in place with their subbies. So if there is any issue with defects, the builder has the right to go after the subby and say, well, no, well, under the terms of the contract, you have to go repair this, you have to go fix this, rectify the defects.

Right. And in this world of today's uncertainty, which doesn't seem to be changing, it seems to be the latest Fashion trend. Why is it so important? Do you feel that all builders should prioritize and focus on this today?

It's important because it's eating into their bottom line. Like, as I said before, like the margin, the profit margin for a building company is really quite small from the outset. So not protecting that profit margin by having these contractual provisions under the contract is going to eat into your profit margin, lead into your cash flow, and they'll. It'll cause a serious effect to your business. Like we asked about some crazy horror stories that I'm seeing homeowners who contact me where builders have tried to sneak in a cost escalation or say 65, $70,000 as a variation. And it's not a variation to the contract, but they're. What can they do? They're trying to do whatever they can. So they're trying to negotiate, they're trying to sit down. But if you don't have that contractual right in your contracts from the outset, well, then you don't have the right.

To claim for it when a new builder comes to work with you or says, look, we need help with our contracts. Take me through your process. Do you go through an assessment process? Do you go through sort of a discovery to understand a little bit about the business? How do you normally. What goes into actually building this contract?

Yeah, sure. I mean, that's a really good question, Bosco. So when we have a builder sit down and you know, as an initial consult, you ask all the questions about the company, what kind of works they do, whether they're, what kind of license they have, for example, whether a builder open or a medium rise, what kind of contracts doing contract price is a very big thing as well. And whether they subcontract those contracts to other subbies or whether they have employees and so forth. And it's really sitting down and asking all those questions will give you an understanding of what the client needs for that contract and discussing about special conditions. And also a big thing is you always get a lot of builders who might always happens, they'll go download a contract off the Internet and they won't read it and they just start signing away. But I always say, like a contract is like it's the rules of the game. And if you don't, if you don't know the rules of the game, well, then you're not playing properly. You need to understand your contract. And that's the biggest thing we sit down with, is like, I'll be a lawyer and I'll explain to you how your contract Works and how to use that contract for your advantage.

Right.

Don't just download a contract and sign away and not think about it. The number of times I've seen builders in breach of their own terms conditions because they haven't read the contract.

I'm scared to ask, but have you ever encountered someone from one country download just a generic, generic contract, but it's actually from another country?

I've seen so many copy and pastes they've amalgamated something that's just morphed into God knows what it is. You'd be surprised the number of contracts like that coming for me in my desk. Yeah.

What do you recommend builders should do to prepare for a meeting with someone like yourself or a law firm? You know, when it comes to like, okay, we need to get our contracts down, we need to renew it or look at it every year. What type of preparation should should occur so that they do this properly? And how does the working engagement work? Is it based on set amount of hours or is there a process? How do you work?

Yeah, sure. So like for a builder sit down with a lawyer should be like on a simple consult or retain arrangement. It's really for the, for the client just to be transparent with the lawyer and answer all those questions that need to be answered for me to get a better understanding as to what the client needs in the contract. Once your contracts in special conditions are prepared, understanding how they work and then it's for the client to then use those contracts properly and then under retain range we have is that sometimes a simple phone call, a 10 or 15 minute phone call will resolve the issue. And that phone call, 10, 15 minutes has actually helped the client to avoid the issue six months down the track, which would turn into a big dispute.

Right. So I've got to ask this question and I know that I think I know the answer. Prevention or cure? Should we have a construction lawyer in our court, in our building, you know, when we need help or do we look for one when the problem is already escalated out of control? Yeah, I'm sure you deal with both.

I deal with both. And I said before, there's always two types of clients. I do a lot more construction litigation, can I say, because unfortunately it's most of those clients only want to talk to the lawyer when it's gone bad already, when it's hit the fan already. But prevention is always better than the cure and they'll actually save themselves a lot of not just costs, but a lot of heartache and a lot of effort. And sometimes you can avoid A situation, and not just because it's costly, but it kind of eats into your, into your life. You know, you're dealing with a litigation dispute that could have been resolved by having proper terms conditions in place or you're in court fighting about oral representations. When that, you know, you should concentrate on what you do best in making more money and running your business rather than having a fight about something when it could have been avoided by having some typical terms conditions in the first place.

And Paul, what should builders look out for in the future? We've talked a little bit about the current times, we've talked about contracts. What are you working or focusing or researching on that builders should be prepared for that potentially could disrupt their way of work.

Yeah, I said before, I think insolvency is going to be a big thing the next, say 12 months or so. I mean, it's going to happen in every industry. Construction industry is going to have a big hit. Unfortunately, we had Covid, which hit the world and it was two fronts hits. We had the health front and now it's going to be the economic impact. It was a good thing what Australian government did in all these government fundings and benefits. But what it created was it's actually a term called zombie companies. So it's these companies which they should not be trading, they should have been liquidation six months ago, but for those government benefits. So you see a lot of those in the construction industry. So a lot of that's now going to be, has to be, I guess, a reset in the industry, in the economy and so a lot of these companies will be cleaned up and move forward into better types of.

Right. So there's a bit of a correction that's about to occur that will change the pathway. Yeah, I'll call it the correction right now for safer reasons. Paul, tell me a little bit about you being a APP preferred member as well. What does that look like for our listeners out there? And tell me a little bit about the arrangement that you have with them.

Yeah, look, I'm very happy and proud to be a member with the Australian Professional Builders. We offer all the legal services and advice to all the members. Any APB member that has any issue or any legal requirements, happy to contact us. And there's no obligation consult at no cost at all. Just a simple discussion. That's our commitment to APB and any issues that come about, we're there to look after the members and help the members through these tough times.

Any final words of wisdom? I think you've given us quite a bit when it comes to what to look out for. But any final words of wisdom for our builder listeners out there?

Yeah, I guess I feel like I've repeated so much about cost escalation clauses, but yeah, really sit down with a lawyer and understand how it works. I guess in some ways it's the most important thing and you'd be surprised if you know how to exercise your right for a cost escalation, how much it can actually help you in the long run. Yeah, don't bear those costs on yourself. Like be be smart and get the right type of advice.

So know your rights, know what to look for, quote accordingly. And more importantly, like an accountant. And like all the other essentials out there, have a lawyer at hand. Treat it as if it's an annual checkup, right?

Yeah, an annual checkup. Go see a doctor. Go see a lawyer.

Awesome. Well, thanks so much for your time and your energy today and we really appreciate the insights as well.

Okay, great. Thanks, Bosco. Take care.

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