Resolution Experts, PC

Protect Your Construction Project from Contract Billing Abuse

By: Jim Schmid Managing Director, ResX, PC;

By: John Sier Partner, Kitch Attorneys & Counselors;

February 2021

Protect Your Construction Project

Don't be a Victim: Safeguard your Construction Project from Contract Billing Abuse.

Construction project owners ("Owners") are frequently the victim of charges for construction services that exceed the amount for which the Owner is responsible. This occurs as a result of contract billing abuse ("Contract Billing Abuse"), which, if particularly egregious, could rise to the level of fraud.

One of the most important functions of the construction auditor is to safequard the Owner from overpaying for construction services. Success of this endeavor relies on several factors:

  1. Establish strong internal controls
    1. The construction contracts
    2. Accounting and administrative procedures
    3. Field reporting procedures
  2. Monitor and benchmark activities and documents
  3. Investigate anomalies and quantify discrepancies
  4. Negotiate with the billing entity to recover any discovered overcharges

Contract Billing Abuse, including fraud, is ubiquitous in the construction industry. It is estimated that 5% of all business revenue is lost due to fraud alone.[1] Proving fraud is difficult because one must prove intent. However, helping the Owner avoid overpaying for construction services is somewhat easier because the focus is on identifying, and recovering, the dollar value of the excess charges. Following is a list of schemes that an Owner may be subjected to that can result in the Owner overpaying for construction services:

  1. Bid rigging
  2. Kickbacks from downstream suppliers or subcontractors
  3. Overbilling for material:
    1. By using inferior material
    2. By diverting materials from the Owner's project
  4. Misreporting minority and/or disadvantaged business content
  5. Charging for unnecessary or idle equipment
  6. Charging labor hours in excess of the hours that actually apply to the Owner's project
  7. Overcharging labor burden rates that exceed actual cost
  8. Charging fee on fee
  9. Charging a tax exempt Owner for sales taxes on purchased material
  10. Charging insurance rates in excess of the actual cost
  11. Understating the amount paid-to-date, thus overstating the amount currently due
  12. Overstating the cost of change orders
  13. Neglecting to subtract the planned cost of work replaced by a change order
  14. Neglecting to subtract the planned cost of work for abandoned scope
  15. Charging the budgeted amount for Allowance work even though the work actually cost less
  16. Using budgeted Allowance dollars to pay for overruns in other areas

There are countless techniques used to overcharge the Owner for construction services. These techniques can be employed in any number of areas in a construction project. Following is a more detailed discussion of risk areas most vulnerable to abuse on a construction project and how to mitigate these risks.

  1. Falsifying Payment Applications

    False pay applications account for more than half of Owner losses. There are many ways pay applications can be manipulated including erroneous totals or line items, roll-forward errors, phony supporting invoices, or inflated rates for labor or equipment. Project managers or project accountants can falsify pay applications to cover up the purchase of personal items or funnel money to a phantom company that they control. Other areas include bogus wage rates and wage categories (i.e., billing for a journeyman when an apprentice did the work); excessive overhead rates; directly charging for costs that are supposed to be covered by the overhead rate; and erroneous markup formula or fee calculations. Pay applications from the construction manager, and its subcontractors, should be closely monitored, tested and recomputed to identify errors or irregularities.

    For further background refer to Alexander v Kent, TX Ct App 2015

    False certifications of amounts owed to subcontractors in payment applications can result in personal liability for the corporate officer writing the checks.

  2. Billing for Unperformed Work

    A contractor or subcontractor may overstate the units of production accomplished, or the units of labor or equipment actually used. For government funded contracts, this could be considered a false claim under the federal False Claims Act. If the contractor passes on a subcontractor's false claim, he or she will likely be treated the same as the offending subcontractor if the false claim is discovered.

    For further background refer to Auburn v Mayotte, MI Ct App 2018

    The owner could not recover from the architect on a design-build project any amounts incorrectly certified since architect did not owe a duty to properly and accurately certify the payment applications or to assess liquidated damages.

  3. Subcontractor Collusion

    Bid rigging and price fixing require some form of collusion and can be difficult to detect. Therefore, it is important to prequalify and pre-approve subcontractors, give them the full scope of work to bid on, and then pick the lowest-priced, most qualified and responsive subcontractor.

    To avoid bid rigging, you must have rules in the contract that guide the subcontractor selection process, particularly if the contractor is allowed to bid against the sub's for trade work. Schemes such as bid rotation, bribes and kickbacks, false or inflated change orders, undervalued deductive change orders or phantom subcontractors that consume the buyout savings all fall under this category.

    For further background refer to

  4. Manipulating Change Orders

    Change orders can be problematic if they are not monitored closely. Many times, issues can be resolved based on a successful relationship between the contractor and subcontractor. Yet, even in those relationships, certain red flags that should be considered as possible fraud indicators: change orders for a base contract's work scope or ones with missing scope descriptions, excess charges, and omissions of design specifications in the original scope of work or improper price reduction for work substitution. In any of these situations, seek additional documentation.

  5. Manipulating the Schedule of Values and Contingency Accounts

    Failing to update Schedule of Values (SOV) line items as buyouts or as changes are made can provide opportunity to cover up fraud. For example, a project manager or project accountant might conceal buyout savings by providing a place in the SOV to charge phony bills received from shell companies (companies that have no independent assets or operations of their own, but are used solely conduct specific business dealings) under their control. If the savings is left buried in the SOV line, an unscrupulous project manager or project accountant can apply fraudulent bills against this buyout savings amount, and the construction company's upper management will not be able to spot this charge by comparing budget to actual performance. This technique can also be employed by subcontractors for material or supplies billed on a pass-through basis.

    Other issues to consider include failing to associate subcontractors/vendors with specific SOV line items, hiding cost overruns during the course of the project or using a contingency to cover non-reimbursable costs.

    For further background refer to

  6. Substituting or Removing Material

    Be sure subcontractors do not use a lower-grade material that requires subsequent change orders to repair/replace later on or materials that can even lead to a structure or system failure. Also, make sure employees have not taken material for personal use. Bait and switch, including in consumer/residential construction.

  7. Diverting Lump-Sum Cost to Time and Material Cost

    Watch out for expenses that may be budgeted in a lump-sum amount but then billed by the subcontractor for time and materials related to these services. For example, is the subcontractor billing time and materials for an industrial vacuum's rental cost, while a lump sum in the budget should already cover that vacuum?

  8. Diverting Purchases and Stealing Equipment/Tools

    Make sure the materials, tools, and equipment you pay for are actually used on your jobsites and not for a different project or an employee's personal use. Watch out for items purchased and shipped to a different project site or project purchases such as equipment or tools that appear to be in excess of project specifications.

    For further background refer to

  9. False Representations

Many contracts require specific terms about the subcontractor's employees, insurance, purchases, etc. For example, a contract may require that all subcontractors have a percentage of minority workers or city residents. Watch out for subcontractors who falsify these representations. Frequently, the contractor will be held responsible for false representations by his or her subcontractors, particularly as it relates to minority content or quality.

False representations might include using undocumented workers, violating "Buy American" requirements or falsifying minority content reports, test results or insurance certificates. Noncompliance with environmental regulations or misrepresentation of small business status can also be false representations. To minimize this risk, maintain copies of documentation confirming (or related to) the subcontractors' representations.

Understanding and recognizing the most common types of construction fraud and establishing internal controls are the first steps in preventing, deterring and detecting fraud. These steps will help prevent your company from falling victim to fraud.

Procedures to Consider

We have reviewed and tested many companies' internal controls, and as a result, have identified several potential tests that can be performed to identify and quantify Construction Billing Abuse:

  1. Schedule out the subcontractor pay applications ("Sub PA's") and compare them to the CM's PA's and the Sub's contract and change orders.
  2. Compare the Sub's change orders to the Owner's change orders
  3. Compare actual to budget on a line-item basis.
  4. Reconcile payments made to the pay applications.
  5. Reconcile the pay applications to the CM's Job Cost Report ("JCR").
  6. Track changes in the SOV.
  7. Track changes in the contingency account.
  8. Analyze the documents underlying expenditures for Allowance work.
  9. Compare change order signature dates to the actual time the work was completed.
  10. Inventory the lien waivers and compare them to the amounts actually paid.
  11. Make a list of purchased equipment, and inventory the remainder.
  12. Conduct supplier confirmations.
  13. Prove reimbursable charges.
  14. Compare material quantities in the spec's to the amounts purchased.
  15. Confirm the delivery location for drop-shipped material.
  16. Confirm the project reference in subcontractor invoices.
  17. Review the subcontractor bid selection process and selection documentation.

[1] The Association of Fraud Examiners ("ACFE's") "Report to the Nations – 2020 Global Study on Occupational Fraud and Abuse"



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