RISK MANAGEMENT IN THE CONSTRUCTION CONTRACTS

There are various procurement methodologies or ‘routes’ by which an employer may wish to procure a construction project. The methodology selected will necessarily affect the allocation of risk in certain respects in the construction contract. A summary of the major methodologies and their primary effects on risk allocation follows.

Traditional procurement

In traditional ‘construct only’ procurement, the employer will engage a design consultant or team to prepare the design for a project and then bid and award a construction contract to a contractor to construct the project in accordance with that design. The employer will take responsibility for the design provided by the design consultant or team and the contractor will be entitled to relief (which may be in the form of an extension of the time for completion and (or) increase in the agreed remuneration) if there are defects or deficiencies in the design (see below).[15]

Design and build

In a design and build contract, the contractor will be responsible for both the design and construction to meet the contractual specification. This offers the employer ‘single point responsibility’ and is an advantage relative to traditional procurement where, for example, it may be difficult to establish whether a defect was caused by a defect or defects in design (and, therefore, the responsibility of the design consultant) or construction (and, therefore, the responsibility of the contractor) (see below).[16]

Engineering, procurement and construction or turnkey

In engineering, procurement and construction (EPC) contracts, a single contractor takes responsibility for all elements of design (engineering), construction and procurement of a project on a ‘turn-key’ basis. While similar to design and build contracts, in EPC contracts the contractor will normally have significant discretion to design the project as it sees fit (so long as requirements of the output based or functional specification are satisfied) and such contracts also typically involve a heavier transfer of risk from the employer to the contractor (see below).

Allocating specific risks

Risks that are typically allocated between the parties in construction contracts include the following.

Quantities

The volume of resources required for a construction project can be a source of uncertainty at the outset of any project. In contracts for a lump sum remuneration, the contractor is paid a fixed amount, regardless of the quantity of resources used. The risk of volumes of resources required therefore sits with the contractor and must be accounted for in the formulation of the contractor’s bid.[18] Conversely, under a remeasurement contract, the parties agree unit rates for the resources required for some or all of the works and remuneration is calculated based on the actual quantities used. In such an arrangement, in effect the employer bears the volume or quantity risk.

Errors in employer-provided information

In construction projects, it is common for the employer to provide the contractor with a range of information, including requirements for what is to be constructed (e.g., the specification for the works), the location and condition of the site on which the works are to be constructed and other factors relating to how the works will be undertaken (e.g., the permits required for the works, the means of accessing the site and prevailing weather conditions at the site). Such information may be provided to the contractor for ‘information only’ on a ‘non-reliance’ basis. In such cases, the risk of errors or inaccuracies in the information will sit with the contractor. Alternatively, the employer may assume some or all of the risk, by allowing the contractor time and (or) cost relief in circumstances where the information provided by the employer proves to be incomplete or incorrect.

Unforeseen ground conditions

The risk of unforeseen ground conditions is well known to the construction industry:

It frequently occurs in practice, particularly in engineering contracts, that unexpected difficulties are encountered during construction which may not only necessitate a change from the expected method of working, but in extreme cases may mean that completion of the work, at least in accordance with the original design, is impossible.[19]

The effects can be felt in terms of time and money: ‘unforeseen site conditions . . . have an obvious capacity to cause delay and disruption to the performance of works on a construction or engineering project, and to cause an escalation in the contractor’s costs’.[20]

Certain types of work have a greater propensity for being affected by ground conditions, but most structures have subsoil foundations of some kind so the phenomenon of unforeseen ground conditions is widely applicable. Accordingly, the potential time and cost consequences should be provided for and taken into account in the parties’ forward planning, which includes tender pricing.

In the suite of contracts published by the International Federation of Consulting Engineers (FIDIC), the Red and Yellow Books have traditionally sought a balanced allocation of risk in unforeseeable physical conditions and related provisions, both as to time and cost. Unforeseen ground conditions are dealt with in a radically different way by the ‘unforeseeable difficulties’ provisions of the Silver Book. (See the section on ‘Unforeseen ground conditions’, below.)

On 7 May 2019, FIDIC published a new Tunnelling and Underground Works Contract (to be known as the Emerald Book), which was a joint initiative by FIDIC and the International Tunnelling and Underground Space Association. The Emerald Book uses the Yellow Book as a base but incorporates risk allocation recognising the nature of the works to be undertaken (in particular in relation to subsurface conditions).

Force majeure

In the course of a construction project, performance of the parties’ obligations can be delayed, impaired or altogether prevented by events outside the parties’ control.

All major legal systems have rules governing the impossibility or inhibition of performance of contractual obligations. The underlying law of the contract selected by the parties, or that which applies in the absence of such selection, is capable of providing remedies and other outcomes to some extent but there is often a significant difference between civil law and common law traditions in this respect.

The concept of imprévision has long formed a part of systems deriving from French law and the doctrine of rebus sic stantibus is expressly incorporated into the German Civil Code.[21]

In the common law systems, and notably in English law, there is no general theory of force majeure, which is not a term of art. The effect is that ‘performance of the relevant obligation must have been prevented by an event of force majeure and not merely hindered or rendered more onerous’.[22]

The difference in approaches between jurisdictions explains why parties to construction contracts routinely make their own express provision for force majeure. The treatment of force majeure (and now ‘exceptional events’) under the FIDIC suite of contracts and some other standard forms of contract is discussed further below.

Change in law

The starting or default position under a construction contract is that, in performing its obligations under the contract, each party will do so in compliance with and so as not to cause any breach of the laws applying to such obligations. In the absence of a specific provision dealing with the consequences of a change in law following execution of the contract, such obligations will remain and, in the case of the contractor, absent any entitlement to an extension of time and (or) additional costs to the extent any delay is caused and (or) additional costs incurred.

Delay

The risk of delay is typically handled by the contract providing for a time for completion by which the contractor is required to complete the works, with liquidated damages for delay becoming payable if the contractor fails to do so. However, to preserve such an approach, under English law, it is important for the contract to allow for the time for completion to be extended in the event of the contractor being unable to comply due to an act of prevention on the part of the employer. In practice, construction contracts will also allow for the contractor to be entitled to extensions if delay is caused by other events specified in the contract (often subject to notice requirements) as part of the risk allocation process described above and below.

Performance guarantees

Where the contractor is constructing a process plant or other facility that will produce a product, the parties often provide for a set of particular performance-related guarantees. The contract will set out a testing and commissioning regime to be complied with before the plant is taken over and, in some cases, afterwards.

As part of the testing regime, certain aspects of the performance of the plant will be measured. To the extent that the plant does not meet the relevant performance guarantee (or guarantees), there are various ways to deal with the shortfall. Most contracts allow the contractor the opportunity to make good any faults to ensure that the relevant performance guarantee (or guarantees) is (or are) met. However, if the contractor fails to meet the relevant performance guarantee (or guarantees) even after attempting to make good those faults, the contract may also provide for payment by the contractor to the employer of liquidated damages by way of compensation to the employer for any limited shortfall in performance. Some contracts will also specify certain minimum performance levels which, if not met, will allow the employer to reject the plant.

Indemnification

The central characteristic of an indemnity clause is that the indemnifier assumes a primary responsibility for the adverse event covered by the clause and undertakes to hold the indemnified party harmless against the consequences of that event.[23] The use of indemnity clauses in construction contracts has been described as ‘governing or re-allocating ultimate contractual responsibility for third party claims as between Employer and Contractor’.[24]

Insurance

Insurance is a mechanism by which risk can be insured for payment of a premium by a third-party insurer pursuant to a contract of insurance. In construction contracts, parties may mandate that the counterparties hold certain insurances to protect the party and the project against certain insurable risks. The FIDIC forms of contract, for example, pre-allocate responsibility for insuring against certain risks and for bearing loss if and to the extent it cannot be insured or recovered from insurance.

-COURTESY Global Arbitration Review