Navigating Global Challenges - best practices regarding management of risks associated with subcontracts and supplier agreements that may include foreign-sourced materials

inline-icon-clock 6 MIN READ 08/12/23

Chris Heider SDI Risk Engineer, Optio
inline-icon-clock 6 MIN READ
Chris Heider SDI Risk Engineer, Optio

Navigating Global Challenges - best practices regarding management of risks associated with subcontracts and supplier agreements that may include foreign-sourced materials

Construction is becoming an increasingly globalized industry with projects sourcing materials from around the world. Foreign sourced material risk in the construction industry is shaped by a combination of economic, geopolitical, regulatory, and logistical factors. While globalization offers cost advantages and access to a wider range of building materials, it also introduces complexities and risks associated with cross-border transactions. Sourcing materials internationally is often driven by a desire to save costs or due to a lack of local availability. However, international outsourcing has been identified as a contributing factor in a number of defaults of subcontractors responsible for procuring materials. Challenges associated with supply chain disruptions, procurement cost overruns, lead times, coordination, communication, quality management limitations, political instability, and payment processing across borders can have a cascading effect on the subcontractor's ability to fulfill their obligations.

There are many important factors for subcontractor partners to consider when sourcing foreign materials. To reduce the risks and the likelihood of subcontractor default, it is crucial for all parties involved to conduct thorough risk assessments, establish clear communication channels, partake in careful planning, and develop contingency plans. The following best practices can help reduce negative project impacts, including a potential subcontractor default.

A thorough evaluation of the proposed foreign source supplier is a crucial first step in ensuring a reliable and efficient supply chain. This evaluation should include an assessment of geopolitical, economic, and regulatory risk that considers political stability, the potential for sudden changes in government policies, currency stability, and regulatory environments in the supplier's country. While the GC evaluates a subcontractor’s financial stability, has the sub completed the same due diligence on the supplier by requesting financial statements, assessing liquidity, and evaluating the supplier's creditworthiness? Have they investigated the supplier's reputation within the industry or received reviews, testimonials, or references from other clients? Other assessment factors when considering a prospective supplier could include quality control standards or processes, supply chain resilience, communication practices, prior performance metrics and KPIs, diversification and redundancy, technology and innovation, scalability and capacity, and systems for continuous monitoring of performance.

Ensuring clear and comprehensive contractual agreements with foreign suppliers have been executed is also essential. A well-crafted contract can help prevent misunderstandings, mitigate risks, and provide a solid foundation for collaboration. Key elements in agreements with foreign suppliers should include – among others – identification of parties, detailed scope of work, delivery terms and conditions, quality standards along with inspection requirements, payment terms – including the currency of payment, intellectual property rights, warranty requirements, insurance requirements, termination and exit clauses, dispute resolution mechanisms, force majeure clause, audit rights, indemnification, communication protocols, governing law and jurisdiction, compliance with international standards, and corruption and anti-bribery clauses. Engaging legal professionals with expertise in international trade and contracts is essential for valuable insights into contract adequacy.

Ensuring foreign source materials comply with local building codes, standards, and regulations is similarly important. For example, the acceptable formaldehyde content in kitchen and bath cabinets.   Cabinets made from various types of pressed wood typically contain formaldehyde and acceptable standards vary across different countries. Adherence to these regulations is essential to avoid legal issues, fines, or disruptions in the supply chain. This, and a wide variety of regulatory compliance issues should be addressed through a thorough analysis of the local laws and regulations in the destination country. This includes import/export regulations, product standards, labeling requirements, and any other relevant legal frameworks including customs and tariffs, product certifications, and environmental regulations or health and safety standards. In addition, documentation and record-keeping can be consequential in these areas and also regarding trade agreements, intellectual property protection, and government/municipality approvals.

Diversifying suppliers of foreign source materials is a strategic approach that helps mitigate risks associated with overreliance on a single supplier. It provides greater flexibility, resilience, and adaptability to changing market conditions. Key considerations for diversifying suppliers of foreign source materials include identifying critical materials, understanding and identifying alternate sources, building relationships, engaging in scenario planning to identify potential risks and disruptions and developing strategies for different scenarios, including supply chain interruptions from primary or alternative suppliers. Also consider whether local or domestic sources for critical materials are prone to supply chain disruptions. This can provide a backup option if foreign supply is compromised.

Transparency and effective communication play pivotal roles in successfully sourcing foreign materials. They foster trust, help mitigate risks, and enhance collaboration between buyers and suppliers across international borders. This starts with clear documentation of the proposed manufacturing and delivery process to help prevent misunderstandings. Regular updates and collaborative planning enhance alignment between buyer and supplier objectives. Transparency of costs (including material costs, shipping fees, tariffs, changes, and any additional charges) further builds trust and helps both parties manage financial expectations. Cultural sensitivity, language nuances, and communication preferences may need to be considered to promote positive and collaborative relationships with foreign suppliers.

Material deposit pitfalls have been identified in a multitude of subcontractor default claims and these issues are exacerbated when dealing with foreign-sourced material deposits. Best practices for handling deposits in the context of foreign-sourced material transactions include negotiation of favorable terms, project owner engagement, gradual payment structures, progress inspections, performance-based deposits or bank guarantees for deposits, and/or escrow services. Legal professionals should review contracts to ensure deposit terms are enforceable and compliant with relevant laws in both the buyer's and supplier's jurisdictions.

Implementing rigorous quality control measures, including third-party inspections, to ensure materials meet specified standards before being incorporated into the construction process, is vital. This includes establishing a plan (including by who, how often, etc.) for progress and quality monitoring of any critical components. Suppliers should be required to provide documentation of product testing and certifications from recognized testing bodies and the authenticity of these documents should be verified. Implementing audit and inspection processes for both quality and performance will help identify and address potential issues in the production process, maintain quality consistency, and mitigate risks associated with foreign sourcing.

Establishing a system to track the origin and movement of materials throughout the supply chain can help identify potential issues and ensure transparency. Effective tracking and traceability systems consider unique identification elements such as barcoding or RFID technology, documentation and record-keeping, and real-time monitoring. Contingency plans should be developed, outlining actions to take when supply chain disruptions or quality issues occur. These plans should detail steps to secure alternative materials or adjust construction timelines. Also, insurance options should be considered that cover potential risks associated with foreign-sourced materials, such as delays, damage, or non-compliance.

Taking time to identify potential risks and build stakeholder collaboration is key. Involving all relevant stakeholders, including suppliers, contractors, architects, and legal experts, helps ensure a comprehensive approach to mitigating the associated risks of foreign-sourced materials and increases the certainty of a successful project outcome.