U.S. Architecture, Engineering and Construction Industry: An Overview for International Investors

(This paper was presented to the Shanghai Association of International Economic and Technological Cooperation in Shanghai on December 10, 2002, and to the China International Contractors’ Association on December 12, 2002, in Beijing. It was serialized in China’s Construction Times newspaper.)

By Paul W. Berning

  1. Introduction

The U.S. construction industry is diverse and huge. It ranges from the plumber or electrician who works alone on residential and small commercial projects to engineering and construction companies that design and build giant, complex projects.

This paper will provide an overview of the U.S. construction industry, describe how it works, and explain the legal and regulatory issues involved with it. The paper will conclude with a discussion of ways to succeed in the U.S. construction market.

  1. Overview

Spending on construction in the United States was $505.6 billion in 2003. This amounted to 4.6 percent of the United States' Gross Domestic Product, which is the total of all money spent in the United States in 2003. Those figures exclude architectural and engineering services, which are separately tracked. By way of comparison, spending in the entire U.S. manufacturing sector was $1,369 billion, which was 12 percent of GDP.

The U.S. construction industry employed 7.3 million people in 2005. Another 1.3 million people worked in architecture and engineering.

  1. Types of Projects and Contractors

U.S. contractors usually specialize based on type and size of project and their role in the project. Construction can be divided roughly into two basic types of projects:

Buildings: Contractors in this sector construct buildings such as homes, schools, hospitals, skyscrapers and high-rise office buildings, low-rise office buildings, apartment buildings and condominiums, facilities for light industry, theaters and shopping centers.

Heavy Construction: Contractors in this sector build factories, process plants, refineries, power plants, highways, roads, bridges, airports, ports, dams, railroads, pipelines, power and telecommunications lines and facilities, sewage plants and systems, and water treatment plants and distribution systems.

There are few contractors in the United States that perform both building and heavy construction projects. Rather, they specialize in one or the other and frequently specialize in a particular sector (heavy contractor that builds highways but not power plants; building contractor that builds single-family housing but not high-rise office buildings.)

There also are two major roles played by U.S. contractors:

General Contractors: These contractors contract directly with the owner and are responsible for getting the entire project built – whether with their own employees or with subcontractors. General contractors manage, schedule and budget the entire project.

Subcontractors: Subcontractors are responsible for building a particular part of a project or performing a particular scope of work. Examples include electrical, plumbing and painting work. Subcontractors are also known as subs, specialty contractors or trade contractors. These names reflect the subcontractor’s role. They are subordinate to general contractors. Electrical subcontractors, for example, specialize in electrical work. Electrical subcontractors employ electricians to perform work, and “electrician” is a recognized trade or type of job in the United States.

General contractors go about their work differently depending on whether they are building or heavy contractors. Heavy contractors self-perform much of the work on their projects, using subcontractors only for specialized tasks. Building contractors use subcontractors heavily and may subcontract all actual construction work, retaining only project management and coordination duties. Other building contractors may self-perform wood framing, concrete foundations and concrete frames. On both building and heavy projects, the contractor selects the subcontractor. In the rare instances when the owner wishes to select a subcontractor, the owner assumes substantial legal liability for the subcontractor.

In 2003, there were 732,175 construction companies in the United States, according to the U.S. Bureau of Labor Statistics. Some 50,905 were heavy contractors, 219,899 were building contractors and 451,371 were trade contractors.

How large a construction company gets to be depends on several factors, including:

  • Desire of the owner. He may want to stay small or he may want to grow.
  • Success – or lack of it – in completing projects. Several bad projects can keep a company from growing. A few more can put the company out of business.
  • Access to capital. The amount of capital available can control how many projects a company can take on, how large the projects are and how risky those projects can be.
  1. Other Participants

There are several other groups of major participants in U.S. construction projects:

Architects, Engineers and Other Design Professionals: These people and their firms design the building or system to be built. Architects generally design buildings while engineers design systems for buildings (structural, electrical, mechanical) and nearly all heavy construction. Other design professionals include geologists (addressing, for example, soil conditions affecting foundations), construction managers, land surveyors, building code consultants, landscape architects, environmental consultants, and lead abatement and asbestos abatement specialists.

Manufacturers and Vendors: These companies provide the specialized equipment for projects and typically sell it to the contractor, who installs it and takes contractual responsibility for it. Vendors are like subcontractors in that they are under contract to the general contractor. But, unlike subcontractors, they supply only equipment and perform no labor on the jobsite.

Suppliers and Materialmen: These companies sell bulk materials, such as lumber, concrete, paint and wire, to projects. Suppliers and materialmen contract with the general contractor or a subcontractor. The buyer is responsible for installing the material.

  1. Types of Owners

There are two main types of project owners in the United States:

Public Owners: These include government agencies at any level of government in the United States: the federal or United States government; any of the 50 states and their agencies; and local governments such as cities, counties (states are divided into counties) or special districts (such as for schools, water treatment or transportation systems).

Private Owners: These include individual persons, families, any kind of business and non-profit organizations (entities set up not to make a profit but to do good works, such as operate a hospital or college).

Public and private owners have building and heavy construction projects of all sizes. About 22 percent of U.S. construction spending in 2006 was on public projects; the balance, 78 percent, was on private projects.

  1. How Projects Are Obtained and the Commercial Organization of Projects

Whether a project is public or private determines how it is obtained and organized commercially. I will first discuss public construction because a good way to understand private construction is to contrast it with public construction.

  1. Public Construction

To prevent corruption and cronyism in government contracting, by the early 1900s all levels of U.S. government – federal, state, local – had adopted a system of public bidding on all government procurement, from pencils to construction.

In construction, the public bidding process works in this way: The government agency obtains a detailed set of plans and specifications for what it wants built. The agency warrants that the plans and specifications are complete and ready to build.

The government agency must publicly announce that bidding is open on the project and allow potential bidders to view plan sets or buy their own sets of plans. The announcement sets a deadline – usually a month or two away – for submitting sealed, written bids to build the project.

The bids are lump sum or hard money bids. That is, the bidder agrees to build exactly what is in the plans and specifications for its quoted price.

When the deadline for submitting bids arrives, the government agency opens the sealed bids. The project is awarded to the bidder that quotes the lowest price.

The process is a straightforward way to obtain the lowest price for a particular project. How government agencies protect themselves from shoddy work by a low bidder is somewhat more complex. First, the architects or engineers who design the project either are employees of the government agency or their architecture or engineering firm is hired by the agency to prepare the design and specifications. That way the government agency controls the quality of what it is buying and what will be included in the project. Second, agencies employ or hire inspectors to ensure that the contractor complies with quality standards in the design and specifications. Third, progress and final payments are made only for work that is completed and completed to the owner’s satisfaction. Fourth, contractors must post a payment and performance bond from another company, called a surety, equal to the entire contract amount. By way of the bond, the surety guarantees that the contractor will pay all of its bills arising from the project, including wages to workers, for materials used and for subcontractors. The surety also guarantees – again by way of the bond – that the project will be satisfactorily completed. If the contractor proves not to have the technical skill, management skill or finances to complete the project, the surety must pay for another contractor to satisfactorily complete the project.

On government projects, sureties typically are large insurance companies. The federal government and private credit-rating agencies rate the credit-worthiness of sureties. Government agencies typically require that bonds be issued by sureties with good credit ratings.

Sureties make money by charging the contractor a fee for issuance of each bond. The fee – typically a percent of the contract amount – is based on the contractor’s financial resources, past track record and market conditions (whether sureties currently are seeking business or being selective).

In order to be able to bid, contractors arrange in advance for a bond to be issued if they are the low bidder. To do so, the contractor must provide a surety with detailed financial information so the surety is satisfied that the contractor has the financial resources to complete even losing projects. Thus, the more financial resources a contractor has, the larger the projects it can bid on. Sureties may insist on collateral, parent company guarantees or even personal guarantees from investors in the contractor to ensure that they, and not the surety, pay for any losses sustained by the contractor. The surety also will consider the contractor’s track record. The surety will write more bonds and for lower rates if the contractor has been in business for years and has successfully completed all of its projects than if the contractor is newly in business or has defaulted on prior projects.

The total dollar amount of bonds that a surety will issue at any one time for a contractor is called bonding capacity. Thus, for example, if a contractor bids on and wins five contracts and their total value equals the contractor’s bonding capacity, the contractor cannot bid on more work until it completes at least one of the projects or convinces its surety to raise its bonding capacity.

Another bond is required to ensure the integrity of the bidding process: the bid bond. This bond is a guarantee that the bidder either will agree to build the project (and provide a performance bond) for its low bid price or will pay the difference between its bid and the next low bid. Thus, bidders must put their financial resources behind their bids. Bid bonds typically are issued by the same surety that will issue the payment and performance bond if the contractor wins the project with a low bid.

Construction of government projects can be summarized this way:

  • Selection of the contractor is strictly controlled by public bidding laws.
  • There is a fixed, lump sum price for the construction. Unless the government owner makes changes, the contractor must build the project for the quoted price – no matter how large its losses may be. That is why such contracts are called hard money.
  • The process is called design-bid-build. That is because plans and specifications ready to build from are prepared first. Then, there is bidding. Then, the project is built.
  1. Private Construction

Owners of private projects are free to select their contractors in any way they wish. They can select based on price, on quality or on some combination of the two. They can have open bidding and invite several contractors to bid. Or, they can work in private with only one contractor. Even if they have competitive bidding, private owners can reserve the right to select any bidder they want (high, middle or low price) for any reason they want (price, quality, long-term maintenance costs, aesthetics).

Nearly all private construction work in the United States is awarded on the basis of negotiation. The negotiation can begin from a variety of points:

  • The project owner can select one contractor and begin negotiations with it.
  • The project owner can work with several contractors and get at least preliminary pricing from all of them before choosing one for final negotiations.
  • The project owner can seek bids from several contractors and then choose one based on price, quality or other factors. Or, having obtained bids, the owner may enter into negotiations with one or more of the contractors.

In evaluating contractors, private owners may look at a number of factors, including:

  • Price. It is a factor for private owners as well as public owners. The private owner may be limited by how much money it has to spend on a project. Or, it may be driven by the return on investment that must be earned by the project. For example, on a process plant or paper mill project, the owner is likely to have calculated how much money it can earn from the output – be it paper or chemicals – from the project. But, if the project costs too much, the rate of return will be too low. This means the project owner will be better off investing its money in something else.
  • Quality. This could be a particular factor in buildings, such as homes, hotels, offices and resorts, where quality and craftsmanship are important.
  • Ability to meet the project schedule. This can be crucial if the work involves additions to or renovations of manufacturing or process plants that will require a shutdown for all or some of the work to be completed. There are a number of contractors in the United States that have a large volume of repeat business because of their proven ability to complete shutdown work on schedule. This ability is valued because the plant is making no money while it is shut down.
  • Ability to complete huge, unique or difficult projects. Many contractors make lots of money and are much-appreciated by their clients for performing the same kinds of work on project after project. Far fewer contractors have the ability – and are trusted by clients to perform – projects that are unusual because of their size, complexity or novelty. For owners of such projects, price may not be as important as the assurance that it has the best contractor for a difficult project.
  1. Structure of Private Projects

Private owners are free to employ the same design-bid-build system used on public projects. But, they may use others as well.

The most common alternative is design-build (the term typically used for constructing buildings) and engineer-procure-construct or EPC (the term typically used for heavy construction projects).

Rather than the steps 1.) design 2.) bid 3.) build, there are different steps in a different order in design-build or EPC projects. Typically, they include:

  1. Owner determines the basic inputs and requirements of the project, such as: Design, procure the equipment for and build a power plant at a particular location, that will burn a particular coal, that will produce a specified amount of electricity and that will be a base load or peaking plant. Or, design and build a warehouse at a particular location, of a particular size, with a specified number of loading docks, concrete floors that will withstand a specified forklift load, and with specified heating and cooling capabilities.
  2. Owner seeks bids from or negotiates with contractors.
  3. Owner selects the contractor.
  4. The contractor designs or subcontracts for the design of the project and builds it. (Industrial projects typically are called EPC because procurement of major equipment, such as boilers for power plants, paper machines for paper mills, crackers for refineries, is so important to the design and to project costs.)
  5. The start of construction is not delayed until design is complete. Rather, construction can begin before the design is complete.

Design-build or EPC contracting lends itself to projects that are easily defined by objective measures ("build me a power plant that generates this much electricity"). It does not lend itself well to projects with important subjective elements, such as fine finishes, important architectural elements or very specific owner needs.

Some of the advantages to owners of design-build include:

  • Shortened project duration because the design and construction phases overlap rather than coming one after the other. This reduces financing costs and makes plants, factories and buildings revenue generators sooner.
  • Shifting performance risk from the owner to the contractor. With EPC contracting, if the power plant does not generate the specified amount of electricity, the contractor is responsible. With a design-bid-build project, the owner is contractually liable for the design, having hired the architect or engineer. If the contractor builds what the engineer designed and the plant does not generate the planned amount of electricity, it is the owner’s loss, not the contractor’s.
  • Shifting construction risk from the owner to the contractor. Because the owner is contractually responsible for the design on a design-bid-build project, the contractor is entitled to extra compensation for correcting any problems arising from the design. Examples include conflicts between piping and structural members or specified components that do not work properly. On a design-build or EPC project, the contractor is responsible for the design and is entitled to no compensation for fixing problems with its own design.
  1. EPC and Design-Build Contracting on Public Projects

Government agencies have noticed the success private owners have had with design-build and EPC projects. In the last few years, special laws have been enacted allowing some federal, state and local government agencies to experiment with design-build and EPC contracting.

Special laws were needed because design-build and EPC contracting do not lend themselves to the public bidding process and its focus on the low bidder. If the successful bidder will both design the highway and build it and if the evaluation is purely on the basis of price, then the bidders will have an overwhelming incentive to design the cheapest possible highway. On design-bid-build projects, government agencies prevent this by controlling the design.

With EPC and design-build contracting, evaluation no longer can be purely objective (lowest price wins) but necessarily must include subjective factors. These may include quality of design, life cycle costs, past track record, perceived commitment to the project, expertise and experience. Involving subjective factors in selection of the contractor poses the risk of re-introducing corruption and cronyism into the government contracting process.

The government experiments in design-build and EPC typically include stringent procedures to keep the selection process fair and honest. Whether the procedures are successful remains to be seen, as the experiments are rather recent.

For now, the government EPC and design-build projects tend to large and complex – the kind that benefit most from design-build.

  1. Pricing Structures

Construction and design services are priced in a variety of ways in the United States. They include:

  • Hourly: Architecture and engineering services often are charged at a rate of so many dollars per hour of service provided. Construction costs sometimes are charged out at an hourly rate.
  • Percent of construction costs: Architecture services sometimes are charged based on a percentage of the ultimate cost of construction.
  • Cost-Plus: The contractor is paid for all of its costs of performance (labor, materials, equipment, management and other services) plus an additional percentage for overhead and profit.
  • Cost-Plus, GMax: This is a variant on cost-plus. While the contractor is paid on a cost-plus basis, the contractor also guarantees the owner that costs will not exceed an agreed maximum (GMax = Guaranteed Maximum Price). Often, the contractor gets a share of cost savings (difference between the GMax and actual costs) as an incentive to control costs.
  • Lump Sum: The contractor agrees to perform the project for a lump sum or fixed price.

These methods of pricing tend to be used on particular types of projects and are driven by factors unique to those projects. Some examples:

  1. Cost Plus:
  • Renovation of, maintenance of and additions to factories and process plants. Because the owner is taking all cost risk, contractors perform the work for extremely thin overhead and profit margins.
  • Small repair and maintenance projects, particularly commercial and residential.
  • Renovation of existing structures where cost of performance may be significantly affected by conditions that cannot be seen before work begins.
  • Extremely risky or unusual projects for which the contractor has no basis to make a cost estimate or would have to include a large contingency.
  1. Cost-Plus GMax:
  • Construction of apartment and office buildings (low- and high-rise), warehouses and light industrial buildings. This work tends to be repetitive, so the risks are relatively low. For owners, this pricing structure keeps profit margins thin and encourages cost savings.
  1. Lump Sum:
  • Nearly all public works projects.
  • Power plants and other facilities that are project financed. (Project financing is obtaining bank loans or floating bonds to build a facility that will generate revenue. The loan is made or the bonds issued on the credit strength of the project itself, not of the company putting together the project.) As a condition of financing such a project, lenders insist that costs be as firm as possible.
  • Any kind of project where pricing certainty is desired and the owner is willing to pay for it. That is, contractors necessarily add contingency to their lump sum prices. The owner pays for the contingency. In exchange for that extra payment, the contractor accepts the risk of all cost overruns – so long as the owner has not caused them by making changes or asking for extra work.
  1. A Note on Quantity Surveying and Estimating

Unlike projects in parts of the world strongly influenced by the British, few projects in the United States are performed on a measured quantity basis. Occasional exceptions are projects involving earth moving and excavation and pricing of extra work (so much a lineal foot for extra pipe or wire). Rather, the pricing structures above are used.

There are no quantity surveyors in the United States. U.S. contractors do measure quantities from drawings in order to develop their estimate or price for design-bid-build projects. Such work is performed by estimators, who may be engineers, former field personnel (former journeyman electrician does quantity takeoffs for electrical bid) and people trained to be estimators. The contractor then looks to its prior experience to determine how many manhours of work it takes to install a particular quantity of work, for example, 10 lineal feet of large diameter pipe. The estimated manhours then are multiplied by the hourly wage rate for the workers who will perform the work.

On EPC and design-build projects, there are no construction-ready drawings from which to do quantity takeoffs. Estimates must be performed on the basis of information from manufacturers (a particular paper machine needs so much pipe of a certain size to support it), conceptually (the layout of the power plant ultimately will depend on the equipment chosen for it, but structural steel quantities are determined based on a possible layout) or factored (the contractor’s prior experience shows that for a particular type of facility, so many lineal feet of power wiring, control wiring, large diameter pipe and small diameter pipe will be needed). The difficulties of performing reliable cost estimates without a complete set of for-construction drawings is another reason why EPC and design-build contracting can be very risky.

  1. Business Climate

The U.S. construction industry traditionally has had low capital requirements and low economic barriers to entry. Contractors tend to have relatively little fixed overhead. Most of their workforce is in the field on projects, not in offices. Workers are hired and let go as needed. Rather than buy large pieces of equipment, contractors often rent equipment on an as-needed basis.

General contractors are paid in arrears for their work. That is, they first perform work and then bill for it – usually monthly. But, general contractors also pay in arrears by not paying subcontractors, vendors and manufacturers until they have been paid by the owner. Retention of 10 percent typically is withheld from payments to general contractors, which retain similar amounts from payments to subcontractors and suppliers. Final payment and retention are due upon substantial completion of the project, which means the project can be put to its intended use and only minor punchlist (or corrective) work remains to be done. On some projects, contractors can post bonds or letters of credit in place of retention.

So, contractors’ capital needs are fairly confined. They include:

  • Funds to pay wages and benefits until progress payments for a project begin to flow. (Wages and benefits typically are paid weekly.)
  • Sufficient financial reserves to obtain needed bonding capacity if public work or bonded private work is to be sought. (Unlike public owners, private owners are not required to obtain payment and performance bonds from general contractors; bonds are optional. However, many private owners require them to reduce project risk although the cost of the bond usually is added to the contractor’s price for the work.)
  • Sufficient reserves to complete any money-losing projects. (Failure to complete a public project almost inevitably will result in a contractor being disqualified from bidding on more public projects. Failure to complete a private project almost inevitably will be a fatal blow to the contractor’s business reputation, resulting in no future business.)

A 1997 Standard & Poor's survey of 5,214 construction companies found that only 50 of them (1 percent) had assets of more than $50 million. Some 58 percent of the companies had assets of $500,000 to $5 million. A 2005 survey by the Construction Financial Management Association was circulated to approximately 4,100 members, 660 companies participated and 532 companies were included in the study. The results were presented on a composite basis and showed per company assets of just over $33 million. (It also showed net earnings before taxes of just over $1.7 million per company on a composite basis.)

The low capital requirements and low barriers to entry mean that the construction business is very competitive. Many owners are aggressive and take advantage of the competition. Profit margins reflect the competition, too. Measured as a percentage of project cost, gross margin (home office overhead and profits before taxes) ranges from 2 to 5 percent for commercial work on cost-plus GMax projects. Pure cost-plus industrial projects may have gross margins of only 2 to 4 percent. Gross margin typically is somewhat higher – 8 to 10 percent – on lump sum contracts because of the risk associated with them. Subcontractor gross margins often are in the 10 to 15 percent range, in part because they often are paid a month later than general contractors. Subcontractors that specialize in complex or niche services may achieve even higher profit margins. Ultimately, profit margins for both general contractors and subcontractors are dependent on economic conditions. In good times, gross margins for subcontractors can reach 33 percent.

Measuring profit as a percent of project costs can be somewhat misleading. For example, suppose a contractor is building a bonded $100 million office building on a cost-plus GMax basis with gross margin of 4 percent or $4 million.

But, suppose the contractor had only $10 million of its capital tied up for the project – in the form of wages and costs advanced, reserves against losses and reserves to satisfy its surety. The $4 million in gross margin represents a 40 percent profit when measured against capital devoted to the project.

Leverage like that means that good projects can be very good. But, it also means that bad projects can be very bad. It is not unheard of to have cost overruns of 25 to 33 percent on lump sum projects. We have had clients come to us facing losses of 60 or 70 percent. If a contractor is winning lump sum contracts with 8 percent profit margins, that means one 33 percent loser can offset all of the profits of four other projects of the same size. Similar problems can arise if a project owner is unable to pay for work performed.

All of this explains why there are a lot of rich contractors in the United States – and why there are some bankrupt contractors, too. For example, the United States’ largest subcontractor (Encompass) is about to file for bankruptcy, and its eighth largest general contractor (Washington Group) filed for bankruptcy a few years ago. Others do very well and have been in business more than 100 years.

We should note that no government agency in the United States has any policy of helping or supporting contractors. While the federal government generally seeks to keep the U.S. economy strong, it does nothing to help the construction sector in particular.

  1. A Note About U.S. Construction Cost Terminology

U.S. contractors divide their costs into project costs for particular projects and home office costs. Project costs are all costs necessary to build a particular project: labor, equipment, tools, materials and management services. Home office costs are those incurred by the construction company that cannot be directly allocated to a particular project. They include costs for executives, accounting, marketing, estimating and insurance. Many contractors use the term gross margin to describe the amount (if any) by which revenue for a project exceeds direct or project costs. Home office costs must be recovered along with profit from any gross margin.

  1. How to Get Started in Business

Focus is the factor most critical to success in U.S. contracting. Focus means:

  • Region: Pick the geographic area or areas that seem most promising for the contractor’s business plan. Construction is a very regional business in the United States. Even the large “national” contractors do not operate in all states at all times. They focus on the states or regions that fit their business plans.
  • Sector: Pick the market sector – and sub-sector – that best fits the contractor’s skills and experience. Be a building contractor or a heavy contractor. Do not try to be both. Within one of those sectors, pick a few sub-sectors that fit in with the company’s business plan. Some very successful building contractors in the San Francisco area stick to building concrete-framed offices, apartments and light industrial buildings. They do not try to build schools or hospitals; they leave those to other contractors. Similarly, heavy contractors that successfully build process plants and refineries do not try to build dams. Successful highway builders do not try to build power plants.
  • Appetite for Risk: Some contractors do quite nicely sticking to a particular niche and building the same kinds of projects over and over. The specialization and repetition lower risks and generate steady if relatively low profits. Other contractors seek higher profit margins by taking on unique or risky projects. The contractor must make a candid assessment of its appetite for risk and capability to successfully complete unique and risky projects.
  • Client Base: Decide whether to build public or private projects. Some contractors successfully seek both kinds of work. But, this is difficult to do because the attitudes necessary to succeed are so different for the two sectors. Public projects are awarded to the low bidder, no matter what his personality or disposition. Private projects are awarded to contractors who provide satisfactory performance and good client service. If a contractor wants repeat business from a private client, he must continue to provide a product that subjectively satisfies the client. A contractor will get repeat business from a public agency only if it is low bidder again. Because public contracts are competitively bid, there is stiff price competition. That means contractors enforce their contracts strictly – even aggressively. There is no reason not to – being nice will not result in more business. Just the opposite is true on private projects – contracts usually must be administered with tact in order to preserve business relationships and the chance for more business. It is hard to be one company and to have two such different approaches to business.
  • Size: Decide what size projects to seek. The decision should be based on experience and available capital. Contractors that are quite successful at building medium-sized projects can fail when they try to build a big project. Similarly, the contractor must have the capital to sustain losses it may incur on the projects it undertakes. Otherwise, one unsuccessful project could put the contractor out of business.

Making the fundamental business decisions necessary to achieve a focused business plan also shapes the contractor’s sales and marketing plan. If public work is to be pursued, then the contractor simply needs to stay informed of the invitations to bid being issued by government agencies that fit with its business plan and bid on those projects that seem promising. The invitations to bid are a matter of public record and open to anyone asking to see them.

If the contractor decides to pursue private work, it must begin marketing itself to project owners and developers that fit with the contractor’s business plan (buildings or heavy; region; size of project). Because construction is so competitive in the United States, potential customers must be convinced that the new contractor has the technical and management skills and financial strength to successfully complete the owner’s project. The novice may have to make price concessions or take on additional risks to break into a market.

  1. Prospering in a Heavily Regulated Industry

The construction industry in the United States is heavily regulated. The regulation does not come from one central source, such as a "Ministry of Construction." Rather, the regulation results because construction involves a number of important public policies that, in turn, involve a number of public agencies.

U.S. contractors use lawyers heavily to find their way through the regulatory jungle. Successful contractors view their lawyers as a resource and a key team member. Successful contractors involve their lawyers in issues early to avoid problems rather than allowing problems to develop and then seeking legal help. It is always cheaper to avoid problems than to resolve them after they have arisen.

Lawyers fill a unique role in the U.S. economy and legal system. Lawyers are required by law and codes of ethics to keep communications with their clients absolutely secret. Complete advice and counsel can be given to the client only if the client can speak to his lawyer in utter confidence. The lawyer cannot help his client break the law. But, the lawyer is obligated to use all of his skills to help his client achieve its business goals in a lawful way.

The legal issues faced by contractors include:

  • Business Structure: Business can be conducted by many kinds of entities in the United States, including sole proprietorships, partnerships, joint ventures, limited partnerships, limited liability partnerships, limited liability companies and corporations.

    Choosing the right structure for a construction company involves weighing many considerations.

    For example, in California, limited liability partnerships cannot obtain contractor licenses. In New York, corporations cannot offer to perform engineering or architecture services. So the business structure must be compatible with licensing laws in the states where the contractor plans to do business.

    Taxes are an important factor, too. Sole proprietorships, partnerships, joint ventures, limited partnerships, limited liability partnerships and limited liability companies pay no taxes on their income or can elect not to. Rather, the income and obligation to pay taxes flow through to the business owners. Corporations pay taxes on their income and then their shareholders pay taxes on dividends and distributions, resulting in double taxation.

    But, exposure to liabilities from the business also is an important consideration. Liability does not flow through to shareholders in corporations, limited liability partnerships and limited liability companies. But, liability does flow through to some or all owners of sole proprietorships, partnerships, joint ventures and limited partnerships. So, it may well make sense to accept more tax obligations in exchange for the liability shield of a corporation.

  • Licensing: There is no federal construction licensing in the United States. Architects and engineers are licensed (or registered) in all 50 states. In many states, their business entities also must be licensed or registered. There is less consistency in contractor licensing. Contractors are licensed in about three-quarters of states. In most states, the licensing focuses on the business entity taking on construction work. But, in some states, the licensing focus is on individual workers. Life safety typically is the concern in those states, with electricians, plumbers and framing carpenters being subject to regulation. States, such as New York, that do not license contractors may allow local governments to require contractor licensing.

    Contractor licensing is one of the most arcane areas of American law because it differs so much from state to state. Some of the licensing laws are out-of-date or anti-competitive. Even so, violation of the laws can bring criminal penalties, including jail time and fines. Most licensing laws provide that unlicensed contractors, engineers and architects cannot sue in court for payments they are owed. California now allows owners to sue unlicensed contractors to recover all payments made to them. Licensing laws also determine whether and how contractors can offer to perform projects on an EPC or design-build basis in a particular state.

    Ultimately, businesses usually can be structured to comply with license laws and achieve particular business objectives. But, the solution may take time (more than 60 days just to obtain a contractor’s license in California) and impact business structures (engineering may not be performed by corporations in New York), which also can raise tax issues.

  • Contracts: Private owners and contractors are free to negotiate whatever contract terms they desire. Sometimes they use form contracts developed by trade organizations such as the American Institute of Architects. Sometimes they negotiate and draft unique contracts.

    On public projects that are competitively bid, there is little or no negotiation of contract terms. The contract usually is a part of the bid package.

    Whether the project is public or private, the contract is a crucial document. It sets out price, payment terms, scope of work to be performed, quality standards, risk allocation between the contractor and owner, schedule, damages, damage limitations, testing and prerequisites to project completion.

    Bad contracts can doom a contractor to a loss before the first shovel of dirt is turned.

  • Bonding: As discussed above, bonding capacity is a necessity to pursue public work and may be needed to seek private work. This will require bond agreements with sureties, which will require indemnity agreements with the contractor and, possibly, with parent companies and investors. Because millions of dollars in liability exposure are involved, such agreements must be carefully negotiated and documented. A relationship with a good surety representative is crucial to a successful construction business in the United States. Lawyers can assist in establishing these relationships.

  • Insurance: U.S. architects and engineers can obtain malpractice insurance – insurance that pays for their legal defense and any damages resulting from their professional errors and omissions. Such insurance is not available to U.S. contractors. However, commercial general liability (CGL) insurance is available to contractors. It pays for their legal defense and any damages resulting from property damage and personal injuries to third parties. Lawyers sometimes can help contractor clients obtain CGL insurance coverage for damages caused by construction defects.

    U.S. businesses also obtain other kinds of insurance, many of which are required by law. They include: worker’s compensation (to pay for injuries to the contractor’s workers; required by law); auto insurance (to pay for damage to the contractor’s vehicles and for damages and injuries to third parties; required by law); course of construction insurance (coverage of project as it is built); officers and directors insurance (for a corporation’s officers and directors if accused of a breach of duty to the corporation); property insurance (on the contractor’s offices, property). Extent of coverage, deductibles, rates, term and conditions can be negotiated and must be documented.

  • Safety: The federal government imposes strict safety regulations on all U.S. industries. Regulations are issued for particular industries, including the construction industry. The regulations are enforced by the federal Occupational Safety and Health Administration or by equivalent state agencies. All U.S. states require businesses, including contractors, to have worker’s compensation insurance, which pays for medical treatment and rehabilitation of injured workers and provides pay to the workers while they recover. Premiums for worker’s compensation insurance are determined by the safety record of particular industries (construction, for example) and of the particular contractor. This experience rating on each contractor is a further incentive to run projects safely. Safety also is a major concern of most project owners and often is a substantial factor in whether private owners will do business with a particular contractor. A poor safety record can result in disqualification from bidding on public works.

  • Building Codes: These detailed technical codes set minimum standards for construction in the United States. For example, they specify how walls should be framed to ensure structural integrity, how plaster and drywall should be installed to ensure fire safety, how plumbing should be installed in buildings so waste water does not contaminate fresh water supplies and how buildings should be designed to assure access by handicapped people. They are drafted by organizations of state and local code enforcement officials, and they are enacted by states and local governments. Most construction in the United States must be designed and built in compliance with these codes. Inspectors employed by state and local governments inspect all buildings during construction to ensure compliance. Work that does not comply must be torn out and re-installed correctly. These codes have a proven record of saving lives and reducing property damage from fires, earthquakes, tornadoes and hurricanes. Consequently, they are strictly enforced.

  • Labor, Employee Relations: The rights of workers are protected by a number of federal and state laws, which are strictly enforced. Workers must be paid a minimum wage; they must be paid 1½ times their usual wage for work in excess of 40 hours a week; they are entitled to unemployment benefits (which are paid by employers); there are limitations on when workers can be dismissed; they cannot be subjected to race, gender or age discrimination. Failure to comply with these laws can result in government penalties and civil suits by workers. For example, Wal-Mart and other large U.S. employers currently face multi-million-dollar lawsuits for allegedly failing to pay workers for overtime.

    In addition, the U.S. construction industry is heavily unionized, particularly on the Pacific Coast, in the Northeast (especially including New York), in the Midwest and in nearly every major urban area. The National Labor Relations Act and other federal laws govern relations between employers, unions and union workers. Lawyers familiar with labor laws are essential to assisting employers in negotiating union contracts and complying with them.

    On public projects, workers must be paid prevailing wages for their craft and area. Often, the prevailing wage rates are identical to or very close to union wage rates.

    (Even in regions or industries where construction workers are not unionized – for example, in petroleum, process and chemical plant construction in the Southeastern United States and Texas – there is stiff competition for skilled workers. As more and more young Americans go to college and pursue non-manual careers, the U.S. construction industry has struggled with a shortage of skilled workers.)

  • Environment: Federal, state and local governments have enacted a number of laws and regulations to protect the environment that affect the construction industry. They include prohibiting runoff of muddy water from jobsites; limiting the amount of air pollution that can be generated by new power plants; mandating the amount and type of insulation required in new buildings to reduce energy consumption; restricting use and requiring proper disposal of toxic chemicals; and regulating handling and removal of substances now considered toxic, such as lead-based paint and asbestos.

  • Taxes: A variety of taxes are imposed by federal, state and local governments in the United States. Of particular concern are federal and state income taxes because they are imposed on business income. Some states impose additional revenue taxes on construction companies. As explained above, tax considerations can drive how businesses are structured. In the United States, people and businesses are free to organize their affairs in order to keep their tax liabilities as low as possible so long as they obey tax laws. Successful businesses, therefore, work closely with their tax lawyers to lawfully minimize their tax liabilities.

  • Imported Materials: Generally, U.S. contractors are free to buy materials anywhere in the world so long as U.S. import duties are paid, the materials comply with the same laws as American materials (example: no lead paint) and the materials meet contractual specifications. However, federal and some state projects require that only American-made materials be used.

  • Foreign Investment: It is welcomed, and there are few restrictions on it. The United States imposes no restrictions of repatriation of capital or profits. Investments are subject to certain regulations.

  • Immigration: Consistent with welcoming foreign investment, visas are available to executives, managers and employees with specialized knowledge of companies that invest in the United States. But, workers who lack specialized knowledge or are not executives or managers of companies making investments will find it difficult to obtain visas. Visa applications are subject to certain regulations.

  1. Disputes in the Construction Industry

Disputes are more common in the construction industry than other industries because each project is unique and because many projects are complex. Some examples:

  • Project Is Completed Late: Did the owner fail to get permits on time, make changes or otherwise interfere with construction? Or, did the contractor simply fail to manage and perform competently? The contractor will seek damages for its costs of extended project duration. The owner will seek actual damages or liquidated damages for delayed use of the project. (Limitations on liquidated damages or other damages are a matter of negotiation between owners and contractors. Owners may not agree to any limitations or may insist on very high limitations, such as 30 or 40 percent.)
  • Defective Construction: Did the contractor fail to perform its work with necessary skill? Or, did inadequate plans and specifications provided by the owner cause the defect? The owner will seek the cost of repair and damages for loss of use. The contractor will resist liability.
  • Extra Work: Is the owner demanding that the contractor perform outside the scope of work described in the contract? Or, is the work within that scope? The contractor will seek payment for extra work. The owner will resist liability.
  • Disruption, Inefficiency: Was the contractor unable to work as efficiently as it planned, thereby incurring extra labor costs, because of events for which it is not responsible under the contract? Examples include owner-caused delays, work schedule compression, excessive owner changes and events for which the owner took the risk under the contract, such as weather or government regulation. The contractor will seek payment for its extra labor costs. The owner will resist liability.
  • Non-Payment: Owners sometimes fail to make progress or final payments to contractors. The owner may lack money to make the payment. Or, it may have a dispute with the contractor and withhold payments to preserve its rights. Or, it may simply be dishonest. State laws provide a variety of remedies to general contractors and subcontractors. They include mechanic’s liens, in which the contractor asserts an ownership interest in the property for payments not made; stop notices, which freeze bank loan proceeds being used by the owner to pay for the project; and prompt payment laws, which penalize owners for unexcused late payments.

Unless the parties agree otherwise, such disputes will be resolved by lawsuits in the courts of the state where the project is located. The disputes will be decided by a jury of 12 citizens unless both parties agree that a judge will decide the dispute. The parties also can agree at the time of contracting or at the time of a dispute to resolution by arbitration. Arbitrations are binding but take place in a private setting, not in a court. The arbitrators – usually three – typically are chosen by the parties. They usually are some combination of lawyers, engineers, architects and contractors. They hear each side of the dispute and enter a binding decision. Many disputes also are resolved by mediation. In those, a neutral third party facilitates negotiations by the parties to the dispute. Any resolution is voluntary and is effective only if agreed to by both parties. And, of course, many disputes simply are resolved by negotiations among the parties.

(Disputes involving federal public projects and some state public projects are resolved by administrative boards or special courts dealing with government contracts.)

  1. Paths to Success in the U.S. Construction Industry

The experience of both U.S. contractors and foreign contractors operating in the United States shows there are three essential elements for success:

  • Strong, experienced management.
  • Skilled personnel.
  • Adequate capital.

For an overseas contractor seeking to expand into the United States, the particular challenge is gaining the experience and skills needed to succeed in the U.S. market.

For example, start-up construction companies can succeed in the U.S. market, but usually they are started by people who gained experience in the construction industry and in a particular market segment while employed by another company. DPR, the 35th largest construction company in the United States, began that way 15 years ago.

If the startup approach is chosen but the company has no experienced employees, then a patient, long-term approach must be taken. The contractor must start with small projects, learn from them and patiently work its way up to larger projects.

Clearly, the surest way to make a successful entry into the U.S. market is to acquire or joint venture with an existing U.S. construction company. In the current slowdown in the U.S. economy, acquisition and joint venture opportunities are available.

Investors can obtain experience by buying a U.S. contractor, thereby acquiring its management and project teams and their experience and expertise. A company in need of capital to expand could be open to a buyout offer or to a substantial investment. Or, the founders and owners of a company who are near retirement age might be open to a buyout offer.

If a construction company is newly formed but has capital available, it could obtain experience by entering into joint ventures with other, experienced contractors. Such joint ventures sometimes are put together to spread the risk of a difficult project or to gather sufficient capital to perform a large project. The new contractor can condition its participation and investment in the joint venture on involvement of its personnel in all aspects of the project so they can learn from the experienced contractor. Construction lawyers can assist in identifying potential acquisition targets or joint venture partners in the U.S. market.

If capital is available for long-term investment in the United States, a contractor can gain experience by building all or part of projects that it will own and operate in the United States. Examples include apartment buildings, office buildings and warehouses. By acting as both owner and contractor, the new contractor can condition hiring other contractors and subcontractors for the project on them involving the new contractor and its personnel in the project so they gain experience and expertise.

Access to capital also may allow a contractor to invest in privatized infrastructure projects, such as toll roads and water systems, as an owner-developer, thereby opening the door to its participation in construction of the project.

Contractors also can secure a commercial advantage by gaining access to a low-cost source of materials. For example, many successful highway contractors own rock quarries and concrete plants. Similarly, contacts that a Chinese contractor has with Chinese manufacturers could, in effect, provide capital by providing the contractor with exclusive access to a source of materials at low-cost relative to the U.S. market.

Similarly, outside the United States, Chinese contractors could be well-positioned to act as subcontractors for U.S. contractors if they can provide large numbers of skilled workers at low cost relative to a particular market, providing an opportunity to learn U.S. construction methods.

  1. Conclusion

The U.S. construction market is complex, competitive and challenging. But, it also is open to new entrants and offers tremendous opportunities, particularly to contractors that are focused, well-organized and well-advised.