Contracts for Contractors

Now that I’m officially closed on my first house, it’s time to start focusing on getting my contractors moving and getting this rehab project underway. I picked a GC earlier this week after several weeks of walk-throughs, bids, and negotiations (I wasn’t very efficient with this the first time around). Tomorrow, I will be meeting with him at the property to sign the contracts, give him his first payment, and review his schedule for the project (so I know what to expect and when).

While I’m sure I’ll deal with plenty of contractors who insist on using their contracts and forms, the GC for this project was perfectly amenable to my creating the contractual agreement, as long as it included his bid as an addendum. I know of several investors who don’t think much about the contractual side of the business, and essentially sign whatever the contractor throws in front them, or in many cases, don’t sign much at all. Considering I have a good bit of money on the line if I get sued (or worse yet, if I get audited by the IRS), I try to be very careful with my contracts and documentation.

For anyone planning to get into this business (even as a hobby), let me recommend that you have a consistent contract regimen with every contractor you work with, regardless of whether it’s a $500 project or a $50,000 project. The risks are the same, and amount of effort to mitigate that risk is really not too great. With that in mind, here are the documents that I require every one of my contractors sign before they start on a project:

IRS Form W-9

A W-9 form is an IRS form that is used to collect information about your contractor (name, address, SS#, etc) that can be used at the end of the year to create and issue tax forms to the contractor and to the IRS. Without the W-9, you risk not being able to get in contact with the contractor at the end of the year to provide him with a statement of earnings for the year. You also run the risk of having no proof of Independent Contractor relationship with the contractor, and may end up paying payroll taxes for that contractor and any wages you paid him.

Some people figure that they’ll be able to collect the contractor’s information at some point in the future, but remember, a contractor may be just as happy if you can’t file tax information about him, so it may actually be more difficult to collect this data after the contractor has completed your job. A W-9 only needs to be filled out once (and kept on file); it’s best to have this filled out by the contractor prior to handing him his first check.

Independent Contractor Agreement

This is a big one, and should be created and signed before each project begins and with each contractor you will be paying. The Independent Contractor Agreement basically lays out the contractual relationship between you and the contractor. Besides containing all the details about the specific project at hand, it clarifies that the relationship between you and the contractor is not employer/employee, but instead an independent contractor relationship. This is very important, both from a legal and a tax perspective. From a legal perspective, it provides you some protection against lawsuit, workman’s comp suit, etc. And from a tax perspective, it will likely save you quite a bit of money in payroll taxes that you’d otherwise pay if the contractor were considered an employee.

Plus, as I mentioned, the Independent Contractor Agreement lays out the specific contractual terms for the project at hand. For example, the contract specifies such things as:

• List of specific services to be performed
• Compensation terms
• Terms around who provides tools, materials, etc
• Penalties assessed for missing deadlines
• Insurance obligations
• Description of how change orders are done
• Etc…

This is the primary contractual document between you and your contractor(s).

Scope of Work

This document may be included as part of the Independent Contractor Agreement or it may be a separate document (usually referenced by the Independent Contractor Agreement). The Scope of Work defines the specific set of tasks you are hiring the contractor to complete, and is essentially his checklist against which he has created his price quote and against the tasks he will be expected to complete to get paid.

The Scope of Work should be as detailed as possible, and should even contain specific information about the materials to be used, where to procure them, etc. If you ever go to court against this contractor for failure to complete his job, the judge is certain to want to see the Scope of Work and compare it to the job performed. The more specific the Scope of Work is, the more likely the contractor will live up to expectations, and if it should ever go to court, the more likely you are to convince a judge that the job was not properly completed.

Payment Schedule

This document may also be included as part of the Independent Contractor Agreement or it may be a separate document (and again, usually referenced by the Independent Contractor Agreement). The payment schedule clearly defines the milestones the contractor needs to hit to get paid, and exactly how much he will get paid at each milestone. What the payment schedule looks like is up to you and your contractor, but suffice it to say, you should be looking to pay as little as possible until a substantial percentage of the job is complete (and of course, the contractor will likely want as much money as possible upfront and early in the project).

When you work with a contractor for the first time, you may find the need to have many payment milestones. For example, here is the payment schedule I try to use when I work with a contractor for the first time:

• Milestone #1: 10% paid when these documents are signed
• Milestone #2: 20% paid after the first day of work is successfully completed
• Milestone #3: 30% paid after half the work is completed
• Milestone #4: 30% paid after substantial completion of the project
• Milestone #5: 10% paid two weeks after substantial completion of the project

Paying essentially 30% at the beginning of the project generally appeases the contractor, and withholding 40% until the end of the project usually encourages the contractor not to slack off or leave your project for another job. Certainly, after working with the same contractor on several jobs, you’ll want to make things simpler by consolidating to just a couple milestones (if not a single milestone); perhaps 50% upfront and 50% at the end of the project.

Insurance & Indemnification Agreement

This form is used to ensure that the contractor provides a reasonable amount of insurance (both liability and workman’s comp) for both himself and any of his subcontractors, employees or agents. This form also obligates the contractor not to sue you for any actions that he or his crew might take. Basically, this is a cover-your-ass document that ensures that the contractor will take responsibility for his crew’s actions and also will provide adequate insurance should there be an accident on the job site.

A lot of people will not use this particular document, but remember, all it takes is one lawsuit to put an end to your business and your savings.

Lien Waiver

A lien waiver is a document signed by the contractor at the end of the job stating that they have been paid everything due to them. By signing this document, they are agreeing not to file any mechanics liens against your property (a mechanics lien is a claim made against your property’s title and can keep you from being able to sell it until the lien is cleared). Make sure that your contractors sign a lien waiver prior to getting their last payment. And refuse to provide payment until the lien waiver is signed, especially if you don’t have a good relationship with that contractor.

Other Documents to Collect

The documents above are the primary documents you need to have signed when working with any contractor. In addition to those documents, you should collect some important information from the contractor and keep it on file in the case where any legal issues later arise. Those documents you could get a copy of from your contractors include:

• Proof of License
• Proof of Liability Insurance
• Proof of Workman’s Comp Insurance
• References