Deconstructing Construction Claims (Part 1)
Forensic accountants explain the methodology to properly analyze economic losses that allegedly flow from construction defects.
Complex construction defect cases usually include architects, engineers and contractors, some of whom may be the claimants, some the responding parties, and some serving as expert witnesses.
Often overlooked in this legal traffic jam is the value of an experienced forensic accountant, particularly one with experience in analyzing damage claims. Such an expert can help assess economic damages, assist in the discovery of fraud and testify about business valuation and related issues in a wide range of situations.
One of the key benefits of working with a forensic accountant is that a savvy expert in this area is trained to utilize skills and techniques which will assist in investigating the claim. A good expert can help reveal crucial facts that will shed much needed light on the underlying claim for damages. This type of analysis merits consideration in the settlement process as well as at trial or arbitration. Indeed, many elements of a construction defect claim may dramatically shift upon probing analysis by a forensic accountant, either getting sharper and more potent, or crumbling under scrutiny.
In this brief three part series, we will examine how this occurs. Our analytical vehicle is a hypothetical claim made by a university in the context of a dormitory construction project that went off the rails.
Let’s assume a university has filed a claim against a contractor, subs, architects, and engineers (to name a few potential parties) for alleged defects in two on-campus housing buildings. We’ll call them Building A and Building B. Construction defects forced the buildings to be taken out of circulation while repairs were made. To correct the problems, the university’s repair plan spanned two school years. Building A was repaired in year 1, Building B in year 2.
Claimed Increase in Furniture Costs
The claim included costs to repair and replace alleged defects and expenses to mitigate lost earnings from taking rooms out of circulation. To accommodate displaced students, select rooms in other dormitories were reconfigured to increase students per room. As defects were repaired in Building A, the rooms were reconfigured to accommodate students from Building B, mitigating lost earnings claims in year 2.
Claimed mitigation costs included installation of temporary furniture and removal and storage of old furniture. Claims for the reconfiguration of Building A also included upgrades for wiring and sprinkler configurations.
The forensic accountants’ assignment was to validate the loss of earnings claim and mitigation costs. Initial analysis involved a review of the proposals, purchase orders and vendor invoices associated with the new furniture and the moving and storage of the old furniture. Early in the review, the forensic accountants questioned how often furniture is replaced and whether the space reconfigurations stemmed solely from the alleged defects.
The university had grown steadily, with continued growth expected. Research of student census projections and capital improvement plans revealed local building restrictions on new construction and expansion of the heights and footprints of existing buildings. The forensic accountants learned that the university already had plans to expand campus housing by increasing density within existing buildings—meaning room reconfigurations would not be temporary to accommodate defect repairs. They also analyzed historical furniture expenses and future budgets to understand the typical life cycle of furniture within student housing.
Analysis showed that the university accelerated plans to increase the number of students per room by two years, meaning they would have had to purchase new furniture to increase building density. The claim included costs to move and store old furniture that was unlikely to be used again. Claimed costs for labor to move furniture in and out would have been incurred irrespective of the alleged defects. It was ultimately determined that all furniture related costs would have eventually been incurred had the alleged defects occurred or not. Further, since additional beds were available earlier than planned, the forensic accountants questioned if the increased profits associated with increased beds and ancillary revenue should offset other claims made.
The forensic accountants also assessed details associated with the hard-cost repairs for the buildings with the alleged defects. The claim included wiring and sprinkler modifications in Building A to mitigate lost earnings during repairs for Building B. Based on further inquiries, the claimed costs included upgrades contemplated within the long-term planning. By accomplishing upgrades during the construction defect repair period, the claimant ultimately saved costs by avoiding the need to reopen the walls and disrupt tenants to re-wire and re-route the life safety systems. The cost savings were quantified and used in negotiating settlement amounts for the claimed construction defect costs.
The use of a forensic accountant with experience reviewing damages can result in the discovery of issues that are not readily apparent in the claim itself. In this case, the review of the claimed loss of earnings revealed that the claimant accelerated plans to increase density in on-campus housing. Costs claimed to reconfigure rooms, move furniture, purchase furniture, upgrade wiring and reconfigure life safety would likely have been incurred by the claimant in any event within two years after the construction defect repairs. Moreover, the changes to increase the available beds resulted in greater profits during the accelerated period at reduced costs.
In short, by working with the right expert, the claimant could properly present a claim that was credible and reasonable, or the defense could demonstrate that the damages were overstated and claimed costs included expenses that would have been incurred irrespective of the alleged defects. Without that help, the damage claim could have been open to attack by the other side.
Coming next: More issues arise as the case unfolds.
Mary E. Furst CPA, ABV, CFF, CFE is a partner in the San Francisco office and James W. McCurley CPA is a director in the Sacramento office of RGL Forensics, a leading financial investigations company.