How to Prevent the Three Most Common Types of Construction Fraud
With material costs on the rise and firms having more difficulty securing credit, fraud is on the rise throughout the construction industry. If you’re an exceptional contractor who wakes up every day trying to make a living by doing honest business, that’s something you can take genuine pride in. At the same time, there are rip-off artists and con-men everywhere, waiting for their next opportunity to take advantage of someone. This article is meant to help you spot the scams before you become a victim. You’ll find out about the most common ways that criminals commit fraud within the construction industry. Armed with this knowledge, you’ll be able to protect your business by spotting scammers from a mile away.
The Most Common Types of Construction Fraud – and How to Prevent Them
1. Falsifying Payment Applications – This is the most important type of fraud scheme to watch out for, as it accounts for over half of all fraudulent activities committed in the construction business. Falsifying a payment application is particularly insidious because it can be very difficult to verify every detail of an invoice, and the best fraudsters will make you feel guilty for doing your due diligence – don’t fall for this! Watch out for the following tricks on any payment applications that you receive:
a. Material costs that seem inflated compared to their market value – request that the applicant includes receipts for items that you’re being billed for.
b. Payment applications that fall outside the scope of work – ensure that contracts are negotiated with an exact scope of work, such that payment applications are received as expected. Sometimes, project managers or other persons within your company can submit pay applications for made-up work – the funds will be paid to accounts or companies that they secretly control. Payment applications should be matched to work orders – not just paid because they exist.
c. Improper wage rates and categories – subcontractors may try to charge a journeyman rate for work that an apprentice did, charge you for rental of a piece of equipment that they already own, or come up with other creative ways to get more money from you than they deserve. These tricks can be hard to detect, so don’t feel bad requesting receipts for any expenses that the subcontractor is forwarding to you along with their payment application as a means of creating transparency.
2. Theft, Diversion, Removal – When construction contractors are given the responsibility of billing you for their expenses, fraudsters see that as a blank cheque to deprive you of some of the materials that you’re paying for, or an opportunity for something even more sinister. Here are some things to watch out for:
a. The subcontractor bills you for Class A material, but purchases and installs Class D material to complete the project. Not only is the work poorer quality and more likely to need repair soon, but you’ve paid premium dollar for a lousy product! On-site material inspections are the best way to ensure that you’re getting what you pay for.
b. The subcontractor bills you for a piece of equipment, but uses it on another job site or for their own project. Equipment that you pay for becomes your property and should only be used for your job – otherwise the subcontractor should pay for it with their own money! Ensure that all equipment purchased on your behalf is required for the project in question by carefully reviewing itemized payment applications, and double-checking that purchased materials are either used in the project or surrendered to you afterward.
3. False Representations – The last type of fraud we’ll discuss is false representations, along with the simple measures you can take to prevent them. A false representation happens anytime you get something different than what you’ve paid for. False representations can occur in many ways:
a. The subcontractor bills you for 18 units of labor when the job took only 12 units of labor to complete.
b. The subcontractor claims that they supervise a skilled team of laborers, but they use undocumented foreign workers for cheaper, less skilled labor.
c. The subcontractor claims to comply with environmental regulations but engages in illegal and harmful practices at your job site, for which you could be held responsible.
To mitigate against these misrepresentations, obtain written documents confirming all the claims and representations that the subcontractor makes to you. An honest subcontractor should have no problem providing you with professional references and evidence that they’re doing things the proper way.
There are almost unlimited ways that you can be defrauded in the construction industry, but there are so many ways that you can protect yourself from those that want to steal from you and hurt your business. In general, you should do your due diligence on the people you work with to avoid getting into trouble. Look up potential partners on Google, ask for references, check out their previous work, or find reviews of their business online.
Internally, it’s very important that you trust your accountants and bookkeepers, and that you keep track of who you’re paying money to and what it’s for. Fraud is what happens when you aren’t paying enough attention to the movement of money and resources through your business, so keep your eyes peeled and you’ll do a great job of protecting yourself.