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Preventing Fraud In Your Organization

in Finance/Homepage Primary

It seems that every day we hear a new story of significant monetary loss due to embezzlement or other crimes perpetrated from within a company by a trusted insider. We hope this column from an earlier edition of St. Louis Construction News & Review Magazine will help protect your business.

By Ken Van Bree

Here’s a statistic that will keep you up at night: according to the Association of Certified Fraud Examiners (ACFE), fraud within the construction industry is now costing an average median loss of $245,000 for organizations. Further, ACFE report that the construction industry’s median loss is approximately $90,000 higher than the average fraud losses across all industries.

Type of Fraud Schemes

The threat of fraud can never be wholly removed, but leadership should take steps to identify schemes their organization might face. Below are a number of schemes frequently used to defraud construction companies.

Billing Schemes

The ACFE indicates that billing schemes account for 35 percent of the fraudulent activity within construction companies. Such schemes can be payments to fictitious vendors, overpayment to vendors (often through collusion with an internal employee), and purchase of personal items with company funds.

Bid Rigging & Corruption

The ACFE reports that nearly 47 percent of the fraud cases examined in the construction industry had an element of corruption, whether it is bribery, kickbacks or quid pro quo situations The bid process can be riddled with opportunity for this type of fraud.

Theft

The construction industry is particularly susceptible to theft of materials due to the location of jobs and the difficulty of tracking construction materials. Job sites can be in remote areas or some distance from the corporate headquarters and subject to less supervision.

Additionally, materials on job sites are hard to track and measure during the construction process. Items lying around a job site such as lumber, concrete, copper pipe, wire and cable can create an opportunity for thieves if proper controls are not in place.

Misuse of Company Equipment

Similar to theft of materials, misuse of company equipment can also become an issue if there is a lack of controls present. For instance, an employee could operate a side business using a company’s idle equipment.

Other Fraud

The construction industry is subject to the same fraudulent activities faced by every other industry. These include payroll fraud through fictitious employees, check tampering, and fraudulent expense reports.

The Importance of Internal Controls

After identifying common fraud activities, an organization should design a control structure that will reduce the opportunity for fraud and increase the chances fraud will be detected. Although there are no guarantees, the foundation to a strong internal control environment is proper segregation of duties.

For example, the person in charge of setting up vendors should not be the same person who approves vendor payments or reconciles bank statements. Proper segregation of duties applies to all areas of business and can be employed effectively at little or no cost.

Here are some other simple yet effective internal controls organizational leadership should consider implementing:

  • Check all estimates for accuracy of calculations, labor rates and correspondence with drawings.
  • Compare job cost estimates with actual costs. Require approvals for cost adjustments or transfers of costs between jobs.
  • Require that estimates for materials above a specified amount include quotes from two or more vendors.
  • Make purchases only with pre-numbered purchase orders, and match them to both receiving reports and invoices before payment is made.
  • Check vendor invoices against estimates to ensure proper discounts and pricing.
  • Always refer to specific job numbers, phase codes or work order numbers in onsite communications.
  • Obtain ink or electronic signatures on change orders before work begins and revise contract values accordingly.
  • Allocate equipment usage to contracts weekly and record equipment maintenance expense in the ledger as they occur.
  • Review all billings for timeliness, accuracy, conformity with contract terms, and correct customer information.
  • Reconcile contract billings with general ledgers monthly, and calculate under-billings and over-billings.
  • Prepare and review monthly financial statements and reconcile them to supporting ledgers, bank statements, and loan schedules

Not all controls are created equal when trying to detect and prevent fraud.  For instance, according to the ACFE, an external audit was performed in 80 percent of the fraud cases reported, but detected the fraud in only three percent of those cases. The majority of fraud was uncovered through tips to a fraud hotline or management, and employees or customers were the leading sources of those tips. A fraud hotline was in place for 54 percent of the fraud cases examined.

Based on this information, it is important not to put too much reliance on a single control, but rather have a series of processes that will prevent and detect fraud.

Know The Signs

The profile of a fraudster can be as important to know as understanding the typical fraud schemes employed themselves. Per the ACFE, fraud typically is not perpetrated by a repeat offender. In fact, only 5 percent of fraudsters had been previously convicted of a fraud-related offense prior to committing fraud crimes.

Additionally, 82 percent of fraudsters had never been punished or terminated by an employer for fraud-related conduct, which shows that while background checks are useful in screening out some bad applicants, they might not be effective in predicting fraudulent behavior.

Most fraudsters were employed for more than one year before committing fraud, but most displayed some, such as living beyond their means, financial difficulties, or having unusually close associations with vendors or customers, that could have served as warning signs. Training management to recognize these warning signs for employees, vendors and auditors is important to help detect fraudulent behavior.

Protect Your Company’s Reputation

Ultimately, knowing the types of fraud, what controls to implement and the profile of a fraudster can help mitigate the chances of a significant fraud loss, but maintaining your reputation is another critical factor.

Reputation is a construction company’s most important asset since the construction industry is small enough for word of mouth to carry great weight in the decision process of sureties, bankers, suppliers or customers. Across all parts of the organization, companies should operate under a code of ethics that builds their reputation in the community.

Ken Van Bree, CPA, is a partner of St. Louis-based accounting firm RubinBrown and serves as the partner-in-charge of the firm’s Construction Services Group. For information, visit

What Do You Mean Our Data’s Gone?!?

in Columns/Technology
Joe Balsarotti
Joe Balsarotti

By Joe Balsarotti. Software To Go

A web-hosting firm we deal with had a disaster recently. The initial problem was beyond their control, then that irritating thing we call ‘human error’ came into play and made a minor disruption into a weeklong catastrophe for its customers.

This brought to light a glaring weakness in most business’ digital disaster plans (assuming the business even has a disaster plan)— their websites. Even if your website is just a glorified brochure for your services instead of a full-blown e-commerce site, you did pay money to have it designed. Ask yourself: who has a backup copy of it? Are you trusting that the hosting company has backups? In the case I mentioned, they did, but they weren’t enough. Maybe you assume the PR firm / web designer / programmer who built your site has backups of it, but they probably do not.

There may be an initial copy of the site as you first had it made, but then over the months and years, you had revisions made to it. Your offerings may have changed, the contact names of your staff as they come and go, graphics, and descriptions all probably morphed as time moved on. (If they haven’t, then your website is in desperate need of a rework) That original copy is now as usable as a faded roll of thermal fax paper.

How many of you have contracted with a backup service for your website? Along with that, how many of you have contracted for an archive of all those years of email for not only you, but for all current and past staff? Are you trusting the first marketing piece a prospect will ever see to someone somewhere in ‘The Cloud,’ who you think/hope/pray is backing it up?

How damaging would it be to your business to have customers and prospects see a blank screen when they expect your website? What goes through their mind when the email they sent you gets returned as undeliverable, not-found, or, even worse, is never acknowledged? All the money you spent on advertising, marketing, and web design all goes for naught in the case of a failure like that.

Email archiving is standard practice in some industries, such as financial, but for most it’s never given a thought as everyone thinks the email company “takes care of that”… right? Well, no. Sure email providers and web hosts probably make backups, but in a world where viruses can sit dormant on systems for weeks or months and then trigger without warning, what good is a backup from last week? That backup is infected too. What happens if the server hosting your website is in a building damaged by a fire, flood, earthquake, or tornado and the backup drive was sitting right next to the server?

The ‘how’ of the failure isn’t the important part of this story, in the end, enormous sums of time, energy and money were thrown at the problem by the hosting firm and the data center they utilized and eventually the customer websites were online again, but with a loss of a week and some irretrievable data. Then again, not all providers would go to the extremes this particular one did to make their customers whole again.

The moral of this story is to make sure you have automatic backups and archiving in place for not just your PCs and servers, but for everything you have in the Cloud, as well. Trusting your company’s lifeblood, its data, to just one provider is a bad plan. Put a backup in place separate from your primary vendor. It’s no doubt the cheapest ‘insurance policy’ your company will ever purchase.

I welcome your questions or comments at businesstech@software-to-go.com

Joe Balsarotti is President of Software To Go and is a 36-year veteran of the computer industry, reaching back to the days of the Apple II. He served three terms as chairman of the National Federation of Independent Business’ (NFIB) Missouri Leadership Council. He was chairman of the Clayton, Missouri Merchant Association for a dozen years. He chaired Region VII of the Federal Small Business Regulatory Fairness Board and currently serves on the Dealer Advisory Panel of the ASCII Group, an organization of over 1000 independent computer and technology solution providers in North America.

Subcontractors’ Mechanic’s Liens Enforceable For Work at Allen Edmonds, Plaza Frontenac

in Columns/Law
James R. Keller
James R. Keller

By James R. Keller, Herzog Crebs LLP

Subcontractors Crafton Contracting Company and Vogel Sheet Metal & Heating, Inc. can proceed to enforce their mechanic’s liens against Plaza Frontenac Acquisition, LLC, owner of Plaza Frontenac shopping mall, general contractor Swenson Construction Company, Inc. and mall tenant Allen Edmonds Corporation. With this result, the Missouri Court of Appeals for the Eastern District reversed a trial court decision that found the liens were not valid.

The case is Crafton Contracting Company and Vogel Sheet Metal & Heating, Inc. v. Swenson Construction Company, Inc., Allen Edmonds Corporation, and Plaza Frontenac Acquisition, LLC, 2016 WL 1469981, decided April 12.

The Eastern District has now made clear that the size of an owner’s property (in this case, the entire mall) should not be the deciding factor in determining whether an agency relationship has been established for the purpose of Missouri’s mechanic’s lien statute.

The parties stipulated to the facts at trial. In 2012, Plaza Frontenac and Allen Edmonds entered into a 10-year lease for space at the Plaza Frontenac mall located at Lindbergh Boulevard in St. Louis County.

The lease required Allen Edmonds to make certain improvements. Allen Edmonds submitted and Plaza Frontenac approved plans for those improvements.

Allen Edmonds accepted the bid of general contractor Swenson Construction Company of $207,398.40 for construction work. Swenson subcontracted demolition, framework, drywall, carpentry and barricade work to Crafton for $67,023.00, and heating, ventilating and air conditioning work to Vogel for $15,975.00. Both subcontractors completed their work.

Allen Edmonds paid Swenson in full. Swenson did not pay Crafton or Vogel. Swenson went out of business in June 2013, prompting Crafton and Vogel to file mechanic’s liens and a lawsuit to enforce them.

Section 429.010 of Missouri’s Revised Statutes (Missouri’s Mechanic’s Lien Act) provides that a mechanic’s lien may be placed upon an owner’s property for “any work or labor” completed upon such land by anyone who contracts with the owner or “his agent.” The issue in this case was whether Allen Edmonds was Plaza Frontenac’s agent.

The Eastern District decided that the term “agent” as used in Section 429.010 must be interpreted broadly. The level of authority required to create an agency relationship is less for a mechanic’s lien action than is otherwise required. This is not a typical principal-agent relationship, but rather, a special, limited agency pursuant to Section 429.010.

The answer to whether there was an agency relationship, according to the appellate court, turned on what the lease required. If the lessee (Allen Edmonds, in this case) was not required to make improvements to the property or to make improvements on its own, no agency relationship exists.

The Eastern District concluded that Allen Edmonds was Plaza Frontenac’s agent. The lease required Allen Edmonds to make substantial and permanent improvements to the property, including that the premises could only be used as an Allen Edmonds store. Allen Edmonds was to submit plans for construction requiring Plaza Frontenac’s approval, and Allen Edmonds was required to perform a complete build-out of the lease premises to conform with Allen Edmonds’ other stores including installation of storefronts and storefront signs, entrance doors, flooring and interior decorating.

The lease also required Allen Edmonds’ contractor to post a security deposit with Plaza Frontenac in case the work was not completed, and provided that all of the improvements became the property of Plaza Frontenac upon lease termination.

The trial court compared the subcontractors’ work to the value of the entire mall. The improvements comprised less than one percent of the mall’s space. The value of the improvements was no more than two percent of the mall’s value as a whole.

The appellate court decided that the trial court’s use of a mathematical equation and its comparison of the leased space to the entire mall misapplied the law.

Instead, the Eastern District emphasized that the subcontractors’ work enhanced the value of Plaza Frontenac’s property. They replaced vacant tenant space with a shoe store, improvements the lease required.

Plaza Frontenac relied on a 1986 Missouri case to support the trial court’s use of a simple mathematical formula to determine agency. This case did not apply, the Eastern District decided. The lease in that case did not require improvements.

James R. Keller is a partner at Herzog Crebs LLP where he concentrates his practice on construction law, complex business disputes, real estate and ADR. He also is an arbitrator and a mediator.

The Risk of Selling on Cruise Control

in Columns/Sales
Tom Woodcock
Tom Woodcock

By Tom Woodcock, Seal The Deal

As companies in the construction industry begin to see life in their sales, they take a big sigh of relief. Finally they have some breathing room. No more stressing on every bid opportunity. Contractors are filling to the brim with work and the insane pricing war is coming to an end. They feel they can sit back and wait for the phone to ring. To be honest, it is ringing more.

Not so fast! Thinking you can put your sales effort on cruise control can be a tragic mistake, a quick way to declining revenues and shrinking profitability. The concept that a sales effort can simply be turned on and off is a flawed philosophy. Any true sales forward company will tell you they are always selling.

Opportunity can be elusive. When it’s plentiful, everyone’s happy. When it’s not, panic can ensue. I regularly challenge my clients to keep pushing the envelope on their sales efforts.

Don’t become lax in approach, financial commitment, or time commitment. It’s easy to do and it is extremely commonplace in the construction industry. Why does it occur? There are some very common causes:

Tangibility: Sales has many intangibles. Sales work often seems fruitless. Most people don’t understand the cumulative aspect of sales work. The construction industry is notorious for wanting A to B results. I put A effort in therefore, I should get B result. You’re fooling yourself if you believe this is the reality of selling. Much of the fruit of a strong sales effort is difficult to trace to a specific action. That can drive owners nuts. They want to try and justify a sales event, lunch, or ballgame.

The sales agent states that the investment was worthwhile, but the bid or order is a long time in coming. This is where I see many companies back off on their efforts and shift into cruise control to handle what simply comes to them. A couple months pass then the well is dry. I’ll have clients that will stop working with me and feel they’ve got it. Then, a month or two down the road, sales are down and the bid requests aren’t flying in at the same high rate. Since sales is far from black and white, contractors struggle with the lack of tangible results.

Fatigue:  Sales work takes effort, such as going to events you’ve been to before or meeting with clients and tracking customer data, to name a few practices. Consistently practicing these disciplines, along with repetitive presentations of competitive differentiation, can sometimes border on monotonous. That can tire even the most enthusiastic of sales personnel. Losing occasional evenings or weekends can be a challenge, especially if you can’t immediately see the results of your efforts. It’s much easier to rest and handle what you have. The more tired you are of selling, the easier it is to stop doing it.

Buy In: Having a staff that doesn’t buy into the effectiveness of sales work can produce pressure that makes that effort even more challenging. People that don’t sell for a living, and are in a support position, can kill the sales drive by challenging the need for a strong selling effort. Selling is a team effort. Getting each department or staff member in lock step is important to maintaining a continuous sales plan. Then all members work together to keep each other accountable in pursuing quality opportunities.

Simply coasting along and not looking to be innovative and consistent in your sales approach can result in a severe drop off in business, especially if the market shifts or competitors target you specifically. Trust me, it will happen, usually before you can get a handle on it. The key is to create a sales culture that permeates the company front to back.

Thinking you’ve locked in your sales direction and believing you can back off on your effort is not a beneficial mentality. Whether done consciously or not, it can result in a deficiency in future sales direction. Panic is no foundation for going after business. Customers sense it and it causes companies to do crazy things, like bidding at cost just to have activity. I’ve seen this happen on many occasions.

Thinking you can slow down or stop selling and fly on cruise control may seem okay, but in reality it is a bad decision. Keeping a good, consistent sales plan based in customer engagement will prevail. Even if you don’t have the capacity to take on more projects, you’re communicating with your client base about exactly where you are. This makes you a desirable option. When you have the room to do so, you can grab the opportunities. The last thing you want to do is disengage with the customer base. Reengaging can be a difficult proposition, which is all the more reason to avoid hitting cruise control.

Tom Woodcock, president, seal the deal, is a speaker and trainer to the construction industry nationwide. He can be reached at his website: www.tomwoodcocksealthedeal.com or at 314-775-9217.

Manage Your Company Finances like a Project Contract

in Columns/Finance
Mark O'Donnell Photo
Mark O’Donnell

By Mark J O’Donnell, CPA, Schmersahl, Treloar & Co

If any one thing is required to succeed in contracting, it is managing the contract. The best contractors have a reasonably well-defined processes for bidding, preconstruction planning, execution and project close out. Very few details are left to chance. Each job is different, and the details are critical to profitability. There are both external factors (unions, other contractors, environment, etc.) and contract changes to be considered. And of course, there is getting paid. In summary the major steps are;

  • Planning (take off, estimate, bid, etc.)
  • Execution
  • Check on benchmarks
  • Modify the contract with CO’s as needed
  • Complete the job.
  • Get paid.

We have noticed that some, but not all contractors take a similar approach to managing the financial health of the business. Consider for a moment how similar the financial process is to the contract management process;

  • Develop an expectation (planning)
  • Execution
  • Check on benchmarks with month to month feedback (timely financials and job reports)
  • Modify the plan based on significant changes
  • Near the end of the year review the results and make key decisions (Complete the job)
  • Get paid

Many privately owned businesses do not plan the year due to a general distaste for ‘budgeting’. No doubt, it is a negative concept. But would you even consider starting a contact without a detailed set of plans? Of course not, it is a recipe for disaster. If you just wing it, you will be lucky to get what you expected. Oddly enough, that is exactly how many of us manage our financial future, we just wing it. The most often used response is related to a general lack of the ability to control the financial results, that they cannot be reasonably predicted. It is very difficult to predict next year’s revenue with pinpoint accuracy. However, our experience is that when asked, many contractors can estimate how they will do (e.g. revenue) the next year with amazing reliability. If you can estimate revenue, most of the balance of the plan can be complied and spread out over a year. Even the most basic effort will establish a basic expectation and an effective tool for decision making.

During the year, monthly financials and job reports are critical to determine if you are meeting your benchmarks / financial objectives for the year. Just like a project, things will go well, or not so well. With timely and accurate financial reports and comparisons to your expectation, information will be there to support decisions to make changes (CO’s if you will) or remain status quo. Without those reports, the year-end results will be a surprise. More importantly, some of the decisions made during the year may not have been optimal, at best. Think about the analogy that was popular years ago. To sail a ship across an ocean, you have a clear starting place and a destination. Along the way there will be regular checks on the ships actual position and thousands of course corrections to deal with the many variables encountered at sea to get back on course. It is true of contract management and financial management as well.

As the year comes to a close, you will need an accurate projection of the financial results for the year, and appropriate advice as well. At least two topics are very important. First, a plan to minimize tax to the company (and its shareholders) over the year just ended, and the next year. Both years must be considered to take advantage of our current income tax structure. Second, a decision regarding how much of the current year’s profits must be retained in the company to build equity and support growth. Accomplishing those two tasks, its time for the owner to get paid!

The similarities between managing a construction contract and your corporate finances are striking. Affixing that same level of attentiveness brings a similar result, a job well done.

Mark J O’Donnell, CPA is a partner with Schmersahl Treloar and Co, a locally owned CPA firm serving successful privately owned businesses, not for profit entities and the professions. A significant portion of the clients Mark represents are either contractors or the companies that serve them. Mark is also Treasurer of the American Subcontractors Association Midwest Council.

Contractor and its Owners Liable for Damages and Attorney Fees

in Columns/Law

By James R. Keller

The Missouri Court of Appeals for the Southern District has upheld a trial court’s judgment in favor of a homeowner and against a contractor and its owners for damages and attorney fees.

The case is Rogers v. Superior Metal, Inc., SD 33696, 2016 WL 442773 (S.D. Mo. Feb. 4, 2016).  This decision may open new personal liability against owners of construction companies.

Superior Metal, Inc. is a construction company that installs metal buildings, roofing, siding and windows.  In 2013, Harley Rogers decided he wanted to build a shed on his property for storage.  He discussed the project with Randy Mueller, one of the owners of Superior Metal.  Mueller told him that “it would be a stand up product” and that “the building would be straight, free of defects, and would be good lumber.”

Rogers and Superior Metal entered into a written agreement for $13,500.00 for Superior Metal to build a pole barn on Rogers’ property.

During construction, Rogers noticed defects and mentioned his concerns to Jonathan Holtzman, co-owner of Superior Metal.

Once completed, according to the appellate court opinion, the building had numerous construction defects.  Rogers demanded his money back.  Superior Metal refused to issue a refund.

Rogers sued for breach of contract, unjust enrichment, fraudulent misrepresentation, negligence, and violations of the Missouri Merchandising Practices Act (MMPA).  Rogers also sued Mueller and Holtzman individually based on an allegation of fraudulent misrepresentation.

The trial was in front of a judge instead of a jury.  The trial court found for Rogers on all counts, awarding $23,500.00 in damages, $10,000.00 in attorney fees, and $1.00 for punitive damages.  The appellate opinion offers no explanation why the award was $23,500.00 when the original contract price was $13,500.00.

The contractor’s first challenge on appeal was that the owner did not present any evidence as to how the alleged construction defects diminished the value of his property.  In Missouri, there are two measures of damages regarding defective performance of a building contract.

One is the cost-to-repair method, and the other is the diminished-value method.  The cost-to-repair method measures damages by the cost of repairing the defective work.  The diminished value method measures the difference between the value of the property before and after the defective work.

The Southern District noted that the cost method is the preferred method to recover damages and that the diminished-value measure should be used when the cost to repair method would cause “unreasonable economic waste.”  In other words, if the cost to repair far exceeds the diminished value of the property, then the diminished value of the property is the proper measure of damage.

In this case, once the landowner presented evidence on the cost to repair, the contractor has the burden to establish that the cost to repair is disproportionately high when compared to the diminution in value of the property.

The contractor presented evidence through an expert that it would cost only $445.00 to repair the defects in the building.  But the contractor presented no evidence regarding the diminution in the value of the property and thus the Southern District on appeal affirmed the trial court’s decision that the damages for faulty construction were $23,500.00.

The appellate court also decided that owners Mueller and Holtzman were individually liable given the trial court’s finding of fraudulent misrepresentation.  Their communications with Rogers, according to the court, were “affirmative participation in the actionable wrong and so justify imposition of individual liability.”  Their personal liability stemmed from fraud, not just breach of contract.  This result will trouble construction company owners.

Regarding attorney fees, the Missouri Merchandising Practices Act allows a trial court to award attorney fees based on the amount of time reasonably expended as well as punitive damages.  Defendants contended that there was no evidence to itemize any attorney fee time and thus no support for attorney fees.

The Southern District concluded that it is well within a trial court’s discretion, as an expert on attorney fees, as well as having familiarity with the case at hand, to decide what attorney fees are proper.

The Southern District also decided that on remand the trial court could determine what attorney fees should be assessed for the appeal since Missouri law allows that the award of attorney fees can include those attorney fees incurred on appeal.

There is no mention of the $1.00 assessed in punitive damages.  The trial court’s decision was affirmed on appeal.  It appears this award stood as well.  A $1.00 punitive damage award usually reflects a statement of disapproval with defendant conduct and is not intended to reflect plaintiff’s actual damages.

James R. Keller is a partner at Herzog Crebs LLP where he concentrates his practice on construction law, complex business disputes, real estate and ADR.  He also is an arbitrator and a mediator.

What’s All This Talk About Encryption?

in Columns/Technology

By Joe Balsarotti

What does the Apple­–FBI fight and the ransom paid by a Hollywood area hospital have in common? Encryption.

The data stored on the Syed Farook’s iPhone and the data at Hollywood Presbyterian Medical Center are both encrypted, the former by design and the latter by malicious hackers.

The lure of privacy and keeping prying eyes away makes encryption a tempting solution, even if no encryption scheme has ever been foolproof. The federal government, through the HIPAA (the Health Insurance Portability and Accountability Act), even wants most patient data encrypted, and yet the FBI wants to break the encryption on mass-murderer Farook’s iPhone.

Encryption is a two-edged sword. It can be used to protect a company’s information, but it can also block a company from getting its own information. When a hard drive fails due to a hardware problem, encrypted information is rarely recoverable. If backups fail, there could be irreparable damage to a business because of the loss. Or, the hardware could be fine, but a disgruntled employee can use readily available tools to encrypt a business’s data and leave the company high and dry.

International organized crime has found encryption to be a very lucrative tool, hence the rise of Cryptolocker and like viruses and malware. “Pay us and you get your data back”; don’t pay and you or your business are at the mercy of having backups with enough versions to extend past when the infection first hit your systems. Of course, that assumes your business *has* backups which have been tested and verified.

Without getting to far into the weeds of the Apple vs. FBI saga, suffice it to say that battle isn’t over encryption, it’s over the iPhone’s setting to destroy it’s data if ten incorrect passcodes are entered. Since today’s computers can easily crack any passcode within a couple of days by trying every combination, the illusion of security in Apple products lie in the balance. Give the FBI a way around the self-destruct and the Apple products are no more secure than anything was before the digital age.

Now, back to the encryption conundrum. Until the digital age, nothing was truly private. Any safe or vault could be picked and any code could be broken, eventually. In the digital age, encryption has become both a blessing and a curse, but there’s no denying that it enables a level of privacy that didn’t even exist  fifty years ago. Those who’ve only lived in the digital age take this privacy as a given and don’t want to see it’s power eroded. Those who remember ‘loose lips sink ships’ know that no information was truly safe in the past, and breaking the other side’s code often meant the difference between life and death.

For a company, encrypting data on mobile devices such as notebooks, tablets, and phones is a prudent move as those devices are easily lost or stolen. However, your data should never be only on such devices. Mobile devices should either have to connect to access the data, via a VPN (Virtual private network), remote access tools like Teamviewer, LogMeIn, or Remote Desktop, or to one of the secure cloud based services. In other words, either store the data stored elsewhere, but have it accessible to your mobile device, or encrypt the mobile copy.

Once important data is encrypted, the key to that data is invaluable. If you as a business owner, encrypt your company data and something happens to you, who on your staff also has the key? If you get hit by the proverberial bus, and no one has the decryption key, how does the business survive without the data you deemed important enough to encrypt in the first place? Restoring a backup won’t help as those backup files would be encrypted and also require the key to be readable. In your personal life, does you family have the keys and passcodes to get into your digital files if you’re incapacitated or no longer around?

Everyone can agree that you should have multiple levels of backups for your business. Whether to encrypt some, all or none of  your company or personal data is a much harder question.

If you’re interested in the specifics of the incidents I mentioned, here are the links:

http://www.latimes.com/business/technology/la-me-ln-hollywood-hospital-bitcoin-20160217-story.html

http://mashable.com/2016/02/25/apple-vs-fbi-stakes/#3e3nDPE1hsqd

I welcome your questions or comments at businesstech@software-to-go.com

Joe Balsarotti is president of Software To Go and is a 36-year veteran of the computer industry. He served three terms as chairman of the National Federation of Independent Business’ (NFIB) Missouri Leadership Council, served as chairman of the Clayton, Missouri Merchant Association for a dozen years, and chaired Region VII of the Federal Small Business Regulatory Fairness Board. He currently serves on the Dealer Advisory Panel of the ASCII Group, an organization of over 1000 independent computer and technology solution providers in North America.

Planning ESOPS for Construction and Real Estate Firms

in Columns/Finance

By Thomas H. Mug

Maybe it’s the preservation of a legacy, perhaps it’s the conclusion of thoughtful succession planning, or it might be a desire to motivate employees and enhance corporate performance … for whatever reason, the construction and real estate industry is increasingly embracing employee stock ownership plans (ESOP).

Indeed, this publication documented the trend three years ago, noting transfers to some form of employee ownership at Brinkmann Constructors, McCarthy Building Companies, CH2M Hill, Parsons, Black & Veatch, HDR, HNTB, Burns & McDonnell and Terracon. Last year, Lawrence Fabric & Metal Structures Inc. and Balke Brown Transwestern, Inc. joined the ranks of employee-owned companies with the help of our law firm, Greensfelder, Hemker & Gale. However, ESOPs are not for every situation and require considerable forethought and planning.

Many businesses begin considering ESOPs as they approach a transition in leadership and want to preserve the distinctive qualities that define the company and its culture and ensure the company’s long-term success. That has been accelerating with a wave of baby boomers entering retirement.

An ESOP is an intense planning process. Business owners should consider the following:

  • Is the firm suited for an ESOP? Business owners should conduct a feasibility study as a first step to determine whether the company is a suitable candidate for an ESOP. This will consider the motivating factors for establishing an ESOP, the financial capability of the company to finance ESOP debt and suitability of the company as an ESOP candidate. The feasibility study will also identify any issues or obstacles in the establishment of an ESOP.
  • Before entering into an ESOP, a business owner needs to know the value of the company. It is likely that the owner will have an expectation of the amount that will be paid for his or her stock. One of the first steps in examining the ESOP as an exit strategy is for the owner to obtain an independent valuation of the company stock. If the result is not to the owner’s satisfaction, the owner may elect to forgo the ESOP and consider other alternatives. Valuation typically involves projecting the future earnings of the company and will rely on those projections of company income. Industry outlook is also a major consideration, as well as the general economic forecast. If appropriate, the valuation may also consider book value and sales of comparable businesses.
  • Federal regulations. ESOPs are heavily regulated by both the U.S. Department of Labor and the Internal Revenue Service. As an ESOP is a retirement plan designed to invest in company stock, the interest of the Department of Labor is to see that plan participants and their retirement savings are adequately protected. Consequently, the Department of Labor will scrutinize an ESOP transaction to assure that the terms of the transaction, including the price paid for company stock, are fair. One way to assure compliance in this regard is to engage a well-qualified independent trustee to represent the interests of ESOP in the transaction.
  • Repurchase obligations. One major consideration for any ESOP, new or mature, is an understanding of the company’s repurchase obligation with respect to its ESOP shares. As employees approach retirement, they will seek to cash out the company stock in their ESOP accounts. In addition to retirement, a repurchase obligation can also occur due to termination of employment, death of an employee or a participant’s exercise of diversification rights. In order to prepare for this eventuality, a company will want to have a repurchase liability study performed and develop a plan to have adequate resources available when the need arises. Failure to plan for this eventuality can result in a crisis in future years.
  • Creating a culture of employee ownership. Critical to the success of any ESOP is the presence of an ownership culture. Some companies have a workplace culture that will give them a head start on this. Others will need to work harder at the developing the ownership mentality. What is important is to have a culture in which employees are engaged as owners and are aware of the responsibilities that come with ownership. This is enhanced through the sharing of information on the financial health and outlook of the company and by developing a team approach to achieve success. An old saying is that there is no “I” in ESOP.

In a sense, a transition to an ESOP takes on the same attributes of a personal family decision. Business owners need to work with financial, legal, and accounting advisors who are familiar with the culture of the firm and its mission. It is a significant advantage when the team has an understanding of the challenges unique to the construction and real estate industry.

It can be more remunerative and sometimes easier to sell to an outside buyer than to embark on an ESOP. The decision depends on the motivation and goals of the owner, the desire for the future of the business, and the feasibility of an ESOP as a succession alternative. Many St. Louis construction and real estate firms have found that properly planned ESOPs are an effective way to develop the next generation of leadership who will continue to advance the legacy of excellence that has defined the company since its inception.

Thomas H. Mug is an attorney in the employee benefits and trust and estates practice groups at the St. Louis law firm Greensfelder, Hemker & Gale, P.C.

Manufacturer Not Liable; Followed MoDOT Plans

in Columns/Law

By James R. Keller 

A manufacturer that follows an owner’s plans, drawings and specifications for a construction project is not strictly liable when a person is injured by the product, Missouri’s Eastern District Court of Appeals decided on September 22.  The case is Hopfer v. Neenah Foundry Co., 2015 WL 5573965.  

In 2009, Norman Hopfer was severely injured when he lost control of his pickup truck after driving over an open drainage inlet on Hall Street in the City of St. Louis.  At least one of the grates covering the inlet was dislodged at the time. 

Hopfer’s lawsuit alleged that Neenah Foundry Co. was liable for his injuries under a strict products liability theory. Specifically, Hopfer alleged that the grates became dislodged due to design defects in that only two open-slot bolts were used to secure the grates.  

Neenah was a manufacturer of the cast-iron grates. Neenah’s normal grates have four bolts fastening each grate to a frame.  In this instance, the grates on Hall Street were modified to use only two-bolt holes. 

Neenah had manufactured the grate under a contract with the Missouri Department of Transportation (MoDOT).  MoDOT installed the grates as part of its road improvement program. 

After a jury verdict in Neenah’s favor, the Eastern District considered two points on appeal:  first, whether the trial court erred by allowing a jury instruction that contained the affirmative defense that compliance with the contract specifications absolved Neenah from liability and, second, whether the jury should have been allowed to consider that Neenah did not perform certain testing when designing the grates.  

Regarding the first point, Neenah contended at trial that MoDOT specified the same grates for the 2005 Hall Street project that previously were manufactured and used in a MoDOT 1999 retrofitting project. 

Hopfer conceded that the grates used in the Hall Street project were the same as those used in the previous 1999 retrofitting project. He argued that the plans for the Hall Street project did not specify the type of grates to be used.  He contended that MoDOT relied on Neenah to design and manufacture the two-bolt grate and to gauge the safety of this product, especially since it was a departure from the standard four-bolt grate typically manufactured by Neenah.  Hopfer also presented evidence that MoDOT does not design roadway grates. 

A Neenah employee and engineer testified that MoDOT and Engineering Design Source, Inc. (EDSI) asked Neenah to change its standard four-hole grate to a two-hole design.  The employee further testified that MoDOT was “controlling the show” with respect to the design and that Neenah “supplied what they asked for.” 

Neenah was not consulted about what type of grates to use in the Hall Street project.  MoDOT engineers decided that the Neenah two-hole grates originally created for the 1999 retrofitting project were to be used in the Hall Street project. After work was completed, a MoDOT engineer on the Hall Street project testified that he had accepted the work as complying with MoDOT specifications, including the two-hole grates. 

Hopfer’s legal theory was strict liability.  Strict liability focuses solely on whether the grates were unreasonably dangerous and therefore defective when made. 

Unlike negligence, a defendant’s conduct, standard of care, and fault in the manufacturing process are not relevant considerations for the jury.  The appellate court decided to uphold previous Missouri law that  compliance with contract specifications is a defense that shields the manufacturer from strict liability. 

On Hopfer’s second point on appeal, he argued that the trial court erred in excluding evidence of Neenah’s failure to conduct Failure Mode and Effects Analysis (FMEA) testing when designing the grate system.
The appellate court agreed that the trial judge correctly exercised its discretion to exclude testing evidence.
 

The court concluded that in a strict liability claim, the sole subject of inquiry is the defective condition of the product. Excluding this evidence was consistent with Missouri’s approach (not followed in many other states) that in claims of strict liability testing goes to defendant’s conduct in designing the grates, which is a consideration the jury should not be allowed to make in a strict liability case.  Such a consideration may be appropriate in a negligence case, but Hopfer only proceeded on the single theory of strict liability. 

The appellate court also declined Hopfer’s request to expand Missouri’s strict liability law to allow for application of the prudent-manufacturer test.  This test states that a product is unreasonably dangerous if a reasonably prudent manufacturer would not have produced and marketed the product in the condition that it was in at the time it was placed into the market.  To the extent other states follow this approach, this appellate court explicitly rejected it under Missouri law. 

James R. Keller is a partner at Herzog Crebs LLP where he concentrates his practice on construction law, complex business disputes, real estate and ADR.  He also is an arbitrator and a mediator.

The New Buzzwords in Technology Aren’t Really Technology at All

in Columns

If you’ve shopped for technology lately, you’ve probably heard some new buzzwords, well acronyms actually, HaaS and SaaS. Neither has anything to do with technology, however, they are all about money. 

HaaS stands for ‘hardware as a service’ and with that said, you may have guessed that SaaS is‘software as a service’. The new moniker, as-a-service, is really an annuity model, where the customer pays a flat rate (usually per month) for the use of equipment and/or software applications. 

One big plus for this model is that budgeting becomes easier for the customer since the payments are fixed over time and the every three to five year ‘hit’ for refreshing technology is spread out. Notice I said spread out. It isn’t eliminated. You will still pay for that new server, new software version, printer, etc. It’s just that you’re paying for it over time. Which brings up
the big minus for this model.
 

You are still paying for the whole amount, but now the cost has interest and inflation factored in. Plus, since the customer never owns the hardware or software under these models, if the agreement is terminated, everything gets picked up and carted off since title almost always stays in the supplier’s name. In other words, the customer may have made payments for years but they don’t own anything in the end. 

Many technology providers are enamored with this new model and its endless revenue stream. For a number of clients, it may indeed be a win-win. Businesses with constantly changing needs, either because of wild fluctuations in employee head count or because they can charge off the tech costs to projects much easier in this way. 

However, for stable businesses using the basics of email, word processing, accounting and industry specific applications, like CAD/CAM that really don’t change over time, HaaS and SaaS may be tossing money into the wind, month after month, from now until doomsday. 

Also worthy of consideration, unlike traditional firms that sell based on the annuity model (insurance companies specifically), these technology companies  have none of the decades, or in some cases, centuries, of experience as to how to correctly price these services. Therefore, these HaaS and SaaS programs are in constant flux, the program you signed up for may be changed or discontinued as the vendor finds their
utilization projections have sent them into the red.
 

In far too many cases, even the sales staff at these vendors are blindsided when changes occur. In one recent case, a SaaS vendor entered into a price agreement with our trade group, only to have the vendor’s company purchased by another firm less than a week later. Their staff had no idea what was going on, the new company had no idea what had just been negotiated and less than two weeks after that, the new firm was purchased by yet another company. Needless to say, months later, customers are in limbo, rollouts are delayed, frustrations are mounting and considerable effort, time and money has
been wasted from all parties involved with nothing to show for it.
 

About everyone does agree that ending one of these agreements causes the most problems. How do you get your data off equipment that’s going away. Who and how much will it cost to move that data to a new provider. Will you need to pay two providers for a transition period so you can be sure there isn’t something missing? 

Is the cost of transitioning out of a ‘bad deal’ so astronomical that it will break the budget, keeping your business stuck with service, or equipment that does not meet your needs and no way to move on? And what happens if your vendor, who carries the title on the as-a-service items gets into financial trouble, or goes belly-up and its creditors come knocking on your door to repo them? 

Deciding on moving to a HaaS or SaaS program from traditional ownership of your equipment and licensing of software is not a decision to be taken lightly. Be sure to weigh all the ramifications and above all, think where your business will be in three, five, ten years. Your vision for the future of your company could be seriously impacted, either for good or for bad, by your decisions on how your technology is provided. 

I welcome your questions or comments.

Joe Balsarotti is President of Software To Go and is a 35-year veteran of the computer industry, reaching back to the days of the Apple II. Joe, served three terms as Chairman of the National Federation of Independent Business’ (NFIB) Missouri Leadership Council, as Chairman of the Clayton, Missouri Merchant Association for a dozen years, Chaired Region VII of the Federal Small Business Regulatory Fairness Board and currently serves on the Dealer Advisory Panel of the ASCII Group, an organization of over 1000 independent computer and technology solution providers in North America.

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