Understanding and exercising audit rights in construction matters
Client background
A healthcare system was completing the fit out of approximately 150,000 square feet of laboratory, clinical, and research space within an existing building. The construction contract was a cost-plus fee with a guaranteed maximum price (GMP), valued at roughly $70 million.
The organization has very robust procurement processes and has developed positive working relationships with many preferred vendors, including the general contractor selected to manage the construction project. The client regularly hires external consultants to conduct construction contract audits to monitor project controls and cost compliance.
The situation
The general contractor selected to oversee the construction has managed many projects for the healthcare system over the life of its extensive capital plan. On this project, in addition to being responsible for project delivery and subcontractor management, the general contractor also self-performed—rather than subcontracting—multiple scopes of work.
The construction contract included specific procurement provisions for disclosing intent to self-perform work, as well as bid procedures and owner approval requirements. Failure to meet all specified requirements prohibited the self-performance of work on a lump sum basis. It also required the execution of GMP self-perform subcontracts with full audit rights consistent with those specified within the prime contract.
Although the contract provisions were well-defined, the general contractor believed that executing lump-sum self-perform subcontracts was appropriate, despite not meeting the requirements.
Key risks this presented to the client included:
- Payment of excessive overhead and profit
- General contractor retention of project savings or contingency that was due in whole or in part to the client
- Movement of contractually non-reimbursable general contractor costs into the lump sum self-perform subcontracts where such cost reimbursement would be undetectable
The solution and results
Baker Tilly provided the following construction audit services:
- Job cost reconciliation. Our team reviewed the contract’s cost-of-work definitions and obtained a transaction-level job cost report for the self-perform subcontract to determine whether overbillings had occurred. Sensitive account types based on contract provisions were identified, and select sample transactions from the cost report were reviewed, uncovering approximately $45,000 in unauthorized travel and entertainment charges.
- Labor audit. The contract stated base wages, payroll taxes, and specific burden components that were cost-reimbursable. We reviewed both the general contractor and the self-perform labor billings—totaling $5.7 million—compared to payroll documents for compliance with the contract and determined over $1.7 million was overcharged, unallowable cost.
Ultimately, both the client and general contractor learned the importance of understanding and implementing contract provisions.
Regardless of the relationship an organization has with a vendor, it’s critical to understand the right to audit clause included within a construction contract to facilitate financial transparency, prevent overpayment, and other costly risks.
We’re here to help
For more information on how your organization can leverage audit rights services, please contact your Baker Tilly professional.