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Best way to protect yourself from contractor fraud/misuse of fund

Posted by athensmomof3 (My Page) on
Thu, Mar 10, 11 at 9:26

I have read several posts on here recently about contractors requiring large upfront sums before construction, and the speculation has been that sometimes these funds are used to pay for ongoing projects, etc.

I realize there is some risk inherent in building a house (heard recently of folks GCing a build who paid a deposit for Anderson windows and the supplier went out of business and spent the deposit (small coastal town)), but I want to know the best way to protect ourselves.

Our builder has a very good reputation, been in business as the same entity for years and years (no switching around corporate names, etc.), etc. I suspect, though, in this economy, most builders have some sort of money issues (either lifestyle has had to come way down, etc.). I do have a personal connection to this builder - our parents know each other and have for years, I grew up with him (didn't know him though), we know lots of the same folks, ours is the first house he is building in this area after moving back from the beach, etc. I do think he has some incentive to not cause problems with this build as this is a small town and word would get out and his business would dry up.

That being said, I do want to do everything I can to be sure the funds we are paying are spent on our house, all liens are released, there is no jacking up of invoices, etc. It concerns me and I want to do what I can to protect myself.

He suggested we open a bank account with him jointly that we could electronically transfer funds to pay contractors, and we would of course only transfer the amount shown by the invoices and would require lien releases. I presume we need lien releases before transferring funds? How does that work (I wouldn't think they would release a lien before being paid).

What is the best way to do this?


Follow-Up Postings:

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RE: Best way to protect yourself from contractor fraud/misuse of

Not sure how to protect yourself except to state your wishes in the contract? As for the draws; DH and me had a const. loan through a credit union and all we did was call the CR when the builder provided us with an invoice and usually it included several, so that we didn't take multiple draws, then they would deposit in our Personal account. We would write a check to the builder for the established amount. Worked for us!
Good Luck!


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RE: Best way to protect yourself from contractor fraud/misuse of

Did you require lien releases? If so, from subs, suppliers or both? I.e., do you get one from the framers AND the lumberyard that provided the materials? What is to prevent you from paying your contractor and him not paying the subs or paying the subs but not the suppliers, etc.? That is the real issue I hear coming up and not sure the best way to prevent that from happening.


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RE: Best way to protect yourself from contractor fraud/misuse of

We did an a fairly large (1100 sq ft) addition, not a new build, but this might pertain to a whole new build.

We worked with our bank on the loan and had 2 options for paying the builder. The first was a bit more expensive, but the bank carried the risk: The bank basically managed the loan money for us and paid the builder after certain criteria were met (inspections, receipts submitted, proof of paying subs.) With the second option, we got the loan and would be responsible for paying the builder and doing all the checks (looking at receipts, etc.) ourselves.

We opted for the first choice. It was more work for the builder but they wanted the job and completely understood our need for the lower risk.

I don't remember what these different options were called by the bank, but it's worth talking to your banker to see what they say. Even if you're not taking out a loan, they might have some services that you could use to manage the payment process.


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RE: Best way to protect yourself from contractor fraud/misuse of

If your builder is dishonest enough, it is nearly impossible to prevent him from not paying subs/suppliers. Requiring lien releases won't work if your builder is dishonest enough b/c he can make such documents out himself and sign them... and also inflate the amounts on invoices so that you pay him more than he contracted with the subs for. All of the above is fraudulent - but getting a DA to bring charges can be nearly impossible. I know. I've been there. It is also nearly impossible to KNOW everyone who is working on your property so you can get hit with a lien from someone you never even knew was ever on your property.

The way it is SUPPOSED to work is this: For ease of numbers, let's assume house will cost $160,000 to build and that builder's profit will be $40,000.

Builder has money of his own sufficient to fund a certain portion of the cost of the build. (say 20% or $32K). Subs/suppliers do work and provide materials for the first $32K of build. Builder pays subs/suppliers for work using his own money. Subs/suppliers provide builder with signed notarized lien releases. Builder takes lien releases to homeowner/banker and requests a draw. One-fifth of work is completed so builder asks for 1/5th of contract price or $40K. Builder reimburses himself $8K and uses the rest of the draw to pay the next set of subs/suppliers to do the next 20% of the work. Cycle repeats until home is completed. After four draws, builder has reimbursed himself the amount he originally invested. The 4th draw also provides the necessary funding to complete the build so that everybody is paid BEFORE builder requests the 5th and final draw. The final draw, released only when homeowner takes possession, is builder's profit.

Unfortunately, many builders don't have the money to fund any portion of the build. They are behind the 8-ball and borrowing from Peter to pay Paul. They can't get lein releases from subs/suppliers in advance of draws b/c they don't have the money to pay the subs/suppliers until they get the draw for the completed work. In fact, you're lucky if they are only using your draws to pay for work that was just done on your house rather than using your money to pay off subs/suppliers that build the LAST house and hoping against hope that some other sucker will come along before they have to pay off the subs/suppliers who are building YOUR house.

Here is the best you can do.

1) Insist on a list UPFRONT of all suppliers and subs that builder plans to use - along with their phone numbers and other contact information - and insist that any deviation from the approved list be pre-approved by you ahead of time.

2) Put in your contact that if any sub/supplier not on the pre-approved list or approved in writing by you files a lien against your home claiming to have done work via a subcontract with builder, builder will fully indemnify you against the lien.

3) Contact each and every listed sub/suppliers before you sign your contract with builder to make sure builder does not already owe them any money.

4) Let Builder AND all subs/suppliers know that you will NOT release any funds to builder without signed NOTARIZED lien releases - so if subs expect to be paid on a timely basis and builder expects to be reimbursed the money he has invested, they must be prompt in getting those lien releases turned in.

5) Make certain that before you release any funds, you have signed, notarized lien releases for the work completed in hand.

5) Find out how long subs/suppliers have to file lien notices in your jurisdiction and put it in your contract that, upon closing, 10% of the build price (taken from the final draw) will be put into escrow to be released to builder upon the expiration of the lien filing deadline but that, if liens are filed in the interim, homeowner may use the funds as necessary to pay off the liens. Some states have a "statutory hold-back" amount and, if you hold back that amount until the lien period has passed, you cannot be held responsible for paying any liens in excess of that amount. I suggested 10% b/c that is my state's statutory hold-back amount.

6) Make certain that builder files an "all bills paid affidavit" in your county land records before you close with him and that he releases any residual liens that he may have against your property if your bank does not fully fund your build.

This is all stuff I wish I had known before we started building. Good luck.


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RE: Best way to protect yourself from contractor fraud/misuse of

Wow...wish I could have read that before we started building! Going to definitely look into #5! I honestly don't think our GC is crooked...just that he doesn't have the backup funds of his own...so behind the 8 ball so to speak. Keeping a close eye on the finances though, and getting site specific lien releases...so the subs are signing that the money he paid them is for OUR project, so he can't pay them for someone elses house with our money. Thanks for the info.


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RE: Best way to protect yourself from contractor fraud/misuse of

The only way to protect yourself is to not pay the builder for more than he has built and for which he can show evidence of payment. It helps to have a design professional to review the status of the work covered by each invoice. A deposit would be held in an escrow account and drawn down according to the terms of the contract. Sometimes retainage is withheld from each invoice, possibly held in escrow and reduced toward the end of the project. This means the contractor finances the project and you will pay a bit more for that service. Unfortunately only larger builders have enough credit to be able to do this.


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RE: Best way to protect yourself from contractor fraud/misuse of

keep his nuts as a retainer and promise to give them back when it's done?
that's the only way i would ever do this again.


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RE: Best way to protect yourself from contractor fraud/misuse of

We are paying all bills. The builder received and expended the downpayment. He provided us with supporting documents and is now requesting a draw. Only DH and I handle the funds from this pont forward. We have all liens for the services purchased with the downpayment. I plan to call each vendor to confirm the lien is legal.


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RE: Best way to protect yourself from contractor fraud/misuse of

Kate LOL...can't wait to see your house- I've been following your progress, well, for a long time. ;0 Your kitchen alone has me checking back here all the time.


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RE: Best way to protect yourself from contractor fraud/misuse of

First time poster but once I saw this thread just had to post.

HANDLE ALL BUSINESS TRANSACTIONS PERSONALLY, CHECK UP ON YOUR BUILDER and know exactly which companies they use so that you can personally check the invoices and accounts :) Speaking from experience, a horrible, terrible experience. We began construction in April 2010 using a Highly recommended builder who was also our Uncle's cousin. We interviewed some of his old clients, some of his current clients, no problems. After we felt confident we signed the contract, got our plans and he began construction. He was professional (receipts, permits etc), the house was coming up in a timely manner and about 3 months in we get a call from the cement company wanting their bill paid. Then we get a call from the Electrician, then the Hvac, then the plumber, lumber company etc....all wanting their money to the tune of $50,000. Then the calls from his other current clients start coming in.... he did the same thing to them. About this time is when he disappears and leaves us with the mess.

Remember this was a relative w/ a good reputation. We thought we took every precaution, receipts from him saying everything was paid and only gave him the exact amount he asked for by using a construction loan with a draw type acct...never gave any extra. But he was using our money to cover his other projects since he had went in debt on them too. For some reason the lumber, cement and other companies were STILL giving him in store credit even though he had hundreds of thousands overdue. In court for two years since they tried to sue him but that pond was dry (took his land, house, vehicles everything) but money was still owed so they tried to come after us. Thankfully our receipts, recorded phone calls and misc info saved us. We plan to build again in the future but will personally manage all the money and have a tight reign on everything that happens throughout the building process.

And he was "jacking up the invoices" too, by about 40%.... never, ever again will I trust any builder with paying my construction bills.

Did I mention we had to replace our roof shingles because they were installed wrong and rotted the wood around the edge? And had to replace the showers because noone waterproofed the walls or sealed the drain so black mold set in? Don't expect inspectors to catch everything either.... Our situation is definitely in the minority but these horror stories do happen.


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RE: Best way to protect yourself from contractor fraud/misuse of

Came across a book the other day that I WISH I had read before we started building. It's called "Crumbling Dreams" by Ruth S. Martin and is is available free on the internet. It'll definitely open your eyes to issues of contractor fraud and incompetence and the total lack of help that homeowners can expect from the legal system if they hire the wrong person. I strongly recommend that anyone getting ready to jump into homebuilding read this first.

Here is a link that might be useful: Crumbling Dreams by Ruth S. Martin


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RE: Best way to protect yourself from contractor fraud/misuse of

I have been having issues with my builder. One thing you definitely should do is require lien releases from any subs before giving him payment. You can also write a joint check made out to him and to his subs so they both have to cash it together. This means there was implied consent that they were both paid. This way you cannot be held liable later if a sub claims he was not paid. Also don't pay in advance if you can help it!


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RE: Best way to protect yourself from contractor fraud/misuse of

Securing your self is only possible if you write all your conditions in the contract otherwise you will be the victim if something happens. Usually business exploits the trust that you do not need to write this because I trust you but in business benefits matters.And there is another aspect that there are some companies which can give you complete advice about contract and contractor money


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RE: Best way to protect yourself from contractor fraud/misuse of

Athens, the way your builder is proposing is exactly what we did. We built cost plus with a fixed fee.

We both happen to bank at the same bank, so I opened a new account and gave my builder online access to that account only. We kept $1 in that account. Weekly, his assistant would email me a scanned copy of all of the invoices to be paid for that week. I would transfer the funds from my savings account into the new account by Thursday evening. Once I made the transfer, she would be able to see it instantly. Then she would transfer the funds out of the new account into their business checking account, leaving the $1 balance. Neither of us could see any of the other accounts the other one had with the bank. After all construction was complete, I had the bank remove their ability to have online access to that account.

Most of the subs pick up their checks from her and would sign their lien waivers when they picked up the check. The rest, she would mail it with the check. The next week when she emailed that week's invoices, she would also send the lien waivers from the previous week.

The builder's fixed fee was paid in 7 draws (if I remember correctly), based upon completion of work. We gave no money to our builder in advance. The last draw was paid after the house was complete.

When we got the original quote from our builder, we had not decided yet to do cost plus. We got a quote from him that was fully broken down and even had copies of the bid for the work submitted to him from most of the subs. The actual invoices we received matched up with the original sub's bids.

We did have a construction loan for our build. We funded all of the construction costs from our savings until we used it up. At that point, we would request a draw from our bank and replenish the savings account. Then we would pay the construction costs until we used it up again and would take another draw.


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RE: Best way to protect yourself from contractor fraud/misuse of

Crooked builders know exactly how to screw you over.

I will add
1. Be proactive!.

Never ever ever allow deliveries that are not for your site.

Watch for HVAC dealer delivering 10 AC unit to your property. When he does not pay for it - it will be you having to deal with lien against your house. All he has to do is request supply house delivery and you are stuck with cleaning up the mess.


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RE: Best way to protect yourself from contractor fraud/misuse of

I pay weekly draws to my builder after I receive detailed invoices showing how much I need to pay. If the work wasn't done, I don't pay. We haven't had this problem, and hopefully won't due to the fact that our builder is a reputable person.


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