[Big Disclaimer: I am not a lawyer and I don’t play one on TV. The information I provide below is just my opinion based on my experiences, and shouldn’t be construed as anything more than that…it certainly shouldn’t be construed as legal advice. If you have any questions about the legal aspects of what I write, I highly recommend you consult a qualified legal professional who no-doubt will know more about the subject than I do. Now, on with the post…]
As someone so focused on building scalable systems in my business, you might guess that I’m a big fan of contracts. And you’d be right!
So, in this post, I want to discuss the most common type of contract that I use as a rehabber – contracts for my contractors. I’ll also touch on a few common misconceptions about contracts and at the end of this post, I’ll even provide a sample contract for your review.
Why I Use Them
I flip about 15-20 houses per year, and on each flip, I use an average of ten contractors. That adds up to about 150-200 contracts per year that I need to write! I could probably save several hours of time by not writing contracts, but one major dispute with a contractor that ends up in court could easily eat up twice as much time (and quite a bit of money as well). So, in my opinion, writing contracts are worth every minute that I spend doing it.
By using contracts consistently throughout all my projects and with all my contractors, I sleep better at night knowing that I’m pretty well protected, both legally and financially. Of course, no contract is bullet-proof, and anyone can sue me for any reason, but having a contract in place makes it all the more unlikely that that will happen; and if it ever does, I’m happy to take my chances in court.
And, not only do the contracts I use protect me and my business, they protect my contractors as well. They know what I expect and they never have to worry about me trying to take advantage of them by adding work or “forgetting” payments. Contracts are a two-way street that – when used properly in this business – can provide a peace-of-mind to both the investor and to the contractor.
But, I’m not going to spend any more time trying to convince you to use contracts for your contractors…instead I’m going to talk a bit about what a good contract looks like…
Before we jump into the details of what a contractor contract should contain, first let’s dispel a couple common myths about contracts:
Myth #1: Contracts need to have a lot of legalese and/or be written by a lawyer to be worthwhile.
A lot of up-and-coming investors will decide that, because they can’t afford to hire an attorney to write their contracts, it’s not worth even having one. While getting a contract written by (or even just reviewed by) an attorney will go a long way towards ensuring that your interests are protected, it’s much better to have a self-written contract than no contact at all. While judges are trained to interpret contracts very literally, they also are reasonable enough to take common-sense and intent into account when resolving a contract dispute. So, don’t forego a contract just because you don’t have a law degree or can’t afford to hire an attorney.
Myth #2: It’s better to have long/complicated contracts than to have short/simple contracts.
We all know that stereotypical contract that’s dozens of pages of small print that covers every possible contingency in gory detail. But, while one purpose of a contract is to protect your (and the other party’s) interests, the other purpose of a contract is to ensure that both parties are on the same page with respect to the transaction at hand. Plenty of contract disputes arise not because one party is looking to “take the money and run,” but instead because the parties never really understood what the other party was agreeing to. Sometimes, all it takes is a couple sentences to reasonably describe each party’s rights and responsibilities, and is enough for both sides to really understand what they’re agreeing to before it’s too late.
Myth #3: You don’t need a contract for a small/inexpensive job.
Just because a transaction only involves a small amount of time and/or money doesn’t mean that a contract isn’t important. Hiring a handyman to screw in a lightbulb for $2 may seem pretty straightforward, but if that handyman electrocutes himself in the process, having a contract may mean the difference between you visiting your handyman in the hospital and you meeting your handyman in court while he’s suing you for everything you’ve got.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
Elements Of A Contractor Contract
With those things in mind, let’s talk about the key components of a contract you might use with a contractor who is working on one of your properties. Remember, these are things that many investors feel are important to have in a contract, but this is by-no-means a complete list of contract issues that might be included in your contract.
Ultimately, you’ll need to decide what things are important for you to have in your contract, and while most of these things below will probably make the cut, that’s for you (and perhaps your attorney) to decide.
Independent Contractor Status: One of the most important things most attorneys will recommend you include in your contract is a very clear declaration that the contractor is an “independent contractor,” and is not your employee. This is important for several reasons:
- From a liability standpoint, you may be required to carry certain forms of insurance for your employees. If your contractor gets hurt on the job, and can make a case that he is an employee of yours (it’s not as far-fetched as you might think!), you may be on the hook to cover his medical expenses and other claims.
- From a tax standpoint, you are required to withhold taxes from paychecks and also to pay certain employer-related taxes. If the IRS deems your contractor an employee (again, it’s more likely than you might think), you may be on the hook for taxes and penalties.
- From a benefits standpoint, if after a job is complete, your contractor claims to have been an employee of yours – and if the unemployment office agrees – you could be on the hook to pay his unemployment benefits.
- From both a liability and from a financial standpoint, it’s extremely important that you clearly define your contractors role in your business – and that role is as an independent contractor, not an employee.
Also, keep in mind that the IRS has a number of tests to determine if someone is an employee or an independent contractor. For example, if you provide the tools to the worker, the IRS will be inclined to consider that worker an employee. Likewise, if you direct the worker as to how the job will be completed, when he must show up and go home, etc, the IRS is more likely to determine that worker is an employee.
For this reason, these sorts of things should be called out specifically in the contract. For example, your contract probably should state that the contractor will provide his own tools.
Scope of Work: Perhaps it goes without saying, but just in case… Your contract should call out – as specifically as possible – the tasks that your contractor is being hired to perform. Don’t be afraid to go into gory detail if you think there is any possibility of confusion or miscommunication.
Will your contractor provide the materials for the job (or maybe some of them)? Will your contractor be required to clean up each day before he leaves? Will your contractor be required to coordinate his schedule with other contractors? Whatever it is, make it clear in the contract.
Compensation: Again, it probably goes without saying, but your contract should define how much and when your contractor will get paid. Perhaps the contractor will get paid based on milestones he surpasses (i.e,. 25% complete, 50% complete, etc). Or perhaps the contractor will get paid upon completion of specific tasks (i.e., 50% upon completion of exterior work).
However you plan to pay your contractor, spell it out clearly in the contract so that there is no confusion once the project has started.
Insurance Requirements: I highly recommend that you require your contractors to carry insurance – both general liability insurance and workman’s comp insurance. Assuming you do have these requirements, make sure it is in the contract. Along with having the contractor agree to carry insurance, I recommend having the contract specify that the contractor will provide proof of this insurance prior to work commencing.
Deadlines and Penalties: One of the most frustrating aspects of working with contractors (in my experience) is that they are happy to drag their feet if you let them. While it’s can be painful to have to argue with a contractor over whether he was supposed to finish this week or next, why argue? Whip out your contract and prove to everyone involved when the work was supposed to complete…and more importantly, what the penalty is for the work not completing on schedule.
I always give my contractors plenty of extra time to complete their work, and also make it clear that if the schedule slips (for reasons not outside their control), they will pay a weekly penalty. I’ve never had to impose that penalty, and I’m guessing it’s in large part because my contractors know what they’ve agreed to and know what the penalty is for missing their dates.
Other Stuff: There are dozens of other terms and issues you can address in your contract that I won’t go into detail on here. To touch on a few: indemnification against liability, arbitration in the event of dispute, rights and responsibilities to terminate the contract, required use of lien waivers, etc. Again, you must decide what’s important to you in a contract and then ensure that it’s adequately covered.
This topic wouldn’t be complete without a sample contract for you to review to get a better understanding of how all these pieces fit together. In this case, I’ll be providing a template of the exact contract I use for every contractor and work task performed on my properties.
Before I provide a link to the contract, a few notes/disclaimers:
- While this contract has been reviewed by my attorney (he wrote much of it), it is specific to Georgia state law and to my needs. You are welcome to do with it what you like, but keep in mind that it may or may not suit your needs and may or may not hold up based on the laws of your state. Who knows, it may not even hold up based on the laws of my state…luckily I haven’t had to find out… J
- The contract I use (and provide below) has two parts. The first part is the “Independent Contractors Agreement” and is signed by each and every contractor before the first time they do any work for me. The contractor only signs this part of the contract once, and it stays in effect forever (or until it’s terminated by either myself or the contractor).
- The second part of the contract is the “Scope of Work” and is specific to each project. This part of the contract lays out the work items to be performed by the contractor for a specific project, the compensation, deadline, penalty, etc and is completed and signed for each new project that the contractor undertakes. The two parts together form the basis for a full contract between your contractor and you for a specific set of tasks at a specific property.
- I’ll reiterate one last time: Don’t assume that this contract will protect you without reviewing it with an attorney to ensure it is applicable to the laws of your state and to ensure that it meets your specific legal needs.
All that said, here the contract templates: