Allocating Risk In Construction Contracts

Every construction project comes with inherent risks. Risk, in a project delivery context, can be defined as an uncertain event or set of circumstances that, should it occur, will have an effect on the achievement of one or more of the project’s objectives. From cost risk (the risk that the project will go over budget) to environmental risk (the risk that the project will be beholden to heritage or environmental issues that may arise), there are a variety of risks to be considered when drawing up contracts for your project.

Here are some common risks for a construction project:

  • Safety hazards that lead to worker accidents and injuries
  • Managing change orders
  • Incomplete drawings and poorly defined scope
  • Unknown site conditions
  • Poorly written contracts
  • Unexpected increases in material costs
  • Labor shortages
  • Damage or theft to equipment and tools
  • Natural disasters
  • Issues with subcontractors and suppliers
  • Availability of building materials

Your contracts should not only account for these possible risks, but also motivate the party doing the work to complete their tasks on time and in budget. Risk allocation occurs in any situation where more than one party (owner, contractor, consultant, etc.) is responsible for the execution of a project. You want to ensure that all risks are recognized and managed. It’s a good practice for any project. This is an important step in that this risk allocation can significantly influence the behavior of the project participants and impact both project performance and final cost.

In any project, the owner’s goal can best be achieved by selecting the contract type that will most effectively motivate the contractor to the desired end while effectively allocating risk. Given the opportunity, an owner should favor efficient allocation of risk between parties to a project that simultaneously reduces risk and improves project performance.

All construction projects come with risks and there is no way to completely eliminate all of those risks. The best you can do is plan for them and allocate them. Disclaimers can be added to contracts in order to shift some of the risk to the contractor, but this can cause problems. When a risk is shifted to the contractor and the contractor has no way to control the occurrence or outcome of the risk, the contractor must either ensure against it or add a contingency to the bid price. Both of which can affect the timeliness or the budget for the project.

Knowing when to accept risk or allocate risk plays a major part in putting together your contracts. While it is possible for parties to negotiate all the terms of any construction contract, a number of standard form contracts have been developed and it is common for one of these standard forms to be used as the basis for the final construction contract. One of the features of standard form contracts is the intent to produce a ‘fair and balanced’ allocation of risk. The rationale for pursuing this is that doing so will provide the best chance of successful project delivery.

Owner Insite is dedicated to helping our clients recognize and allocate risk to ensure the best possible outcome for their project. Contact us today for a free demo.

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