Construction Fraud/Waste/Abuse Case Study III:
The Role of the Construction Auditor in Construction Claims
The construction auditor's role is to give the construction project owner ("Owner") assurance that the construction manager or general contractor ("CM") has complied with certain aspects of the construction project contract ("Contract"). The construction auditor ("Construction Auditor" or "CA") can be engaged at any point before, during, or at the conclusion of a construction project ("Project") and the CA's scope, as stipulated in its engagement agreement, can be very narrow or very broad. Generally, the CA is engaged to help the Owner confirm that the CM submitted pay requests in a manner consistent with the terms of the Contract for the work completed by the CM.
During the course of its work, the CA will become familiar with the Contract, and the policies, procedures and documents used by the various parties to manage the Project. The CA performs tests of the Project's records and sometimes, if material anomalies are discovered, the CA may investigate that anomaly as part of its original engagement scope or as a change to its original scope (i.e., a change order).
If a dispute between the CM and the Owner erupts over contract payments during the course of a Project, the CA may be in a position to assist in the resolution of that dispute.
This raises the question, "can the Construction Auditor help the Owner and is the CA a fact witness or an expert witness?" The answer to this questions is, "it depends." It depends on the depth of the CA's professional expertise and credentials and it depends on the CA's engagement letter and the Project's Contract.
All CA's must be able to quantify overbillings and billing errors. In addition, some CA's have the skills needed to investigate construction claims that go beyond contract billing compliance, such as skills needed to evaluate damage claims based on delay, acceleration, disruption, changes in conditions, changes in scope, or consequential damages.
This blog cannot address all the possible twists and turns that can occur when considering whether and how to use the Construction Auditor as an expert consultant or expert witness in a construction dispute. It will, however, discuss some of the important points Construction Auditors, Owners, and attorneys should consider when deciding whether and how to engage the CA in a construction dispute.
Why Use the Construction Auditor as a Consulting Expert or Expert Witness in a Construction Dispute
The CA has deep knowledge of construction norms and specific knowledge regarding the Project's contract, policies, procedures and documents. In many situations, the CA may be the first to uncover a CM overbilling or billing error. The CA can perform investigations into potential CM overbilling or billing errors through reliance on the Contract's Audit Rights Clause and by doing so, reduce the time needed to document the relevant issues need to achieve a settlement.
Additionally, many contracts have Audit Rights Clauses that stipulate that the cost of the CA audit/investigation is the responsibility of the CM if the audit uncovers billing errors in excess of a specified percentage (i.e., 1% or 2%). Therefore, if the CA uncovers/documents overbilling or billing errors in excess of the contractual threshold, then the cost of the CA's services moves from the Owner to the CM.
The Construction Auditor's Engagement Letter
When a Construction Auditor wishes to have the option to act as an expert witness for the Owner, if a contract dispute or CM claim should occur, then the CA should include language in its engagement letter that establishes the ability to do so. Two ways of potentially accomplishing this are:
1) Define the scope of the original engagement so that it includes the prospect of acting as an expert witness if litigation ensues.
2) Narrow the engagement scope to only perform contract compliance tests and stipulate that if an investigation is warranted as a result of the contract compliance tests, then this investigation will be conducted under a new agreement that will be with the institution's legal counsel.
In the unlikely circumstance where the Owner wishes to have the auditor's records keep from discovery in litigation, then a possible means of accomplishing this is to have the CA contract directly with Owner's legal counsel and designate the CA as an expert consultant to the attorney. However, under this situation, the Contract's Audit Rights clause may have language that stipulates who can inspect the CM's records and this language may preclude an "expert consultant" from being the Owner's representative auditor.
The Construction Contract – Records Retention Clause
The Contract's Records Retention Clause should anticipate the needs of the Owner during the Project and if the Project evolves into a dispute. These records should be kept for at least period of three years and the Owner's designated representative should have a right to inspect and copy these records for a period of at least three years.
A good Records Retention Clause will require that, during the Project, the CM will routinely provide accounting and administrative documents/data in machine-readable form. It is particularly important that the monthly, and Project-to-date, Job Cost Report be provided in either Excel or some other application where character recognition and data manipulation (i.e., searching and sorting) can occur. Other reports that should be provided in readable form include:
1) Labor Distribution Detail
2) Daily Foreman and/or Supervisor Reports
3) All logs (Equipment Usage, RFI, PCO, Contingency, Buy-Out Savings, etc.)
4) Meeting minutes
5) Subcontractor pay applications
6) Vendor invoices
Additionally, the Contract should require that all subcontracts, written signed by the CM with Project subcontractors, must comply with the Records Retention Clause.
The Construction Contract – Audit Rights Clause
The Contract's Audit Rights Clause should be able to accommodate the situation where the Project is moving to litigation and the Owner wishes to have access to all the relevant information related to contract compliance and billing accuracy. Key elements of the Audit Rights Clause that support this scenario include:
1) Allow any accounting or audit representative designated by the Owner to inspect the CM's records.
2) Require that all subcontracts written by the CM for Project subcontractors comply with the Audit Right Clause
3) Establish the Owner's right to inspect all records that are necessary to adequately permit verification of compliance with:
- Plans and specifications
- Ethics expectations
- Change order pricing
- Accuracy of CM billing representations
4) Allow the Owner's representative to interview all current and former employees regarding issues relevant to the Project
What Can The Construction Auditor Provide As Expert Consultant or Expert Witness
The scope of what a CA can do as an expert witness in a construction dispute is limited by his/her expertise and professional credentials. Clearly, all qualified Construction Auditors should have the following skills, which are needed to identify, quantify, and document CM overbillings and billing errors:
1) Well versed in the normal industry practices
2) Skilled in interpreting the Contract
3) Understand the Project's policies, procedures, and documents
4) Skilled in interviewing Project participants in order to understand how things were done and identify areas of billing risk
5) Able to design and conduct test intended to identify areas of potential overbilling or billing errors
6) Able to conduct investigations of high risk areas in search of evidence of overbilling or billing errors
7) Ability to quantify company overhead rates and labor burden rates
8) Able to document overbillings or billing errors
Some CA's have the additional skills that are needed to investigate construction claims that involve delay, acceleration, disruption, changes in conditions, changes in scope, or consequential damages. These skills include:
1) Analytical experience required to quantify:
- Measured mile criteria
2) Schedule experience including critical path scheduling
3) Engineering experience including cost estimating
4) Local and national market research experience related to patterns in:
- Material costs
- Labor costs
- Other competitive issues
The Construction Auditor ("CA") has unique knowledge and access to the records underlying a construction project. This knowledge and access can be used proactively by the Owner to its benefit, in anticipation of a potential contract dispute, assuming it is used in compliance with the rules of the construction contract and the CA's engagement letter. The construction contract's clauses related to Records Retention and Audit Rights are particularly important with regard to leveraging the position of the Owner in anticipation of litigation. Finally the question of whether the CA should be viewed as a fact witness, expert consultant or expert witness will depend on the CA engagement letter, the issues in dispute and the CA's own expertise and credentials.
Resolution Experts PC, "ResX, PC", provides independent forensic accounting services for construction auditing and construction contract compliance. ResX is based in Michigan and serves clients throughout the United States. For more information and to learn about working with ResX, please visit our website: www.resxpc.com.
The preceding narrative presents concepts that are dependent on facts and circumstances. These concepts can change depending on the specific facts and circumstances of an individual matter.