11 AfDB New Procurement Policy: Training Program for the Bank s Procurement Staff Risk Allocation in Construction Contracts
Risks 2 In the absence of a contract, all risks are the owner's Contracting is a process of risk allocation between the two contracting parties: The Employer & the Contractor The more risks transferred to the Contractor, the higher the contract price
Risks cont. 3 There are many RISKS relating to Construction Contracting The impact of those RISKS if they materialize is financial, damage to the project, and/or injury to persons
4 It is paramount to identify risks so that the probability of such risks materializing may be assessed, and thus such risks may by allocated in an optimal manner
5 Sources of Risk in Construction Projects Operational Physical Construction Environmental Political Design Legal Logistics Financial
Sources of Risk in Construction Projects cont'd 6 Physical: Loss or damage by fire, earthquake, flood, accident, landslip. Environmental Ecological damage, pollution, waste treatment. Design New technology, innovative applications, reliability, safety Detail, precision and appropriateness of specifications Logistics Loss or damage in the transportation of materials and equipment Availability of specialized resources expertise, designers, contractors, suppliers, plant, scarce construction skills, materials Access and communications Organizational interfaces.
Sources of Risk in Construction Projects cont'd Financial Availability of funds, adequacy of insurance Adequate provision of cash flow Losses due to default of contractors, suppliers Exchange rate fluctuations, inflation Taxation Legal Liability for acts of others, direct liabilities Local law, legal differences between home country and home countries of suppliers, contractors, designers Political Political risks in countries of owner and suppliers, contractors war, revolution, changes in law 7
Sources of Risk in Construction Projects cont'd 8 Construction Feasibility of construction methods, safety Industrial relations Extent of change Climate Quality and availability of management and supervision Operational Fluctuations in market demand for product or service Maintenance needs Fitness for purpose Safety of operation.
Types of Risks in Construction Projects cont. 9 First: Risks relating to Physical Works Physical Conditions Changed or differing Site Conditions Instability of natural or constructed slopes soft ground, rock Groundwater Artificial obstructions underground services wells, pits, shafts, boreholes, etc. debris, refuse, contaminated ground
Types of Risks in Construction Projects cont. 10 First: Risks relating to Physical Works cont. Adverse weather and natural disasters affecting site conditions surface flooding, erosion acts of God: earthquakes, volcanic activity, typhoon Defective materials or workmanship Faulty Design
11 Types of Risks in Construction Projects cont'd Second: Risks relating to Delay Late Site Possession Late Drawings, Instructions Loss of Productivity Delay Outside the Parties' Control Shortage of Staff, Labour, Plant, Materials, Finance Delay Damages
12 Types of Risks in Construction Projects cont'd Third: Risks relating to Direction & Supervision Incompetence, Inefficiency, Unreasonableness Lack of Communication Loss of Productivity Shortcomings in Measurement & Evaluation Acceleration or Suspension of the Work
Types of Risks in Construction Projects cont'd 13 Fourth: Risks relating to Damage to Property Due to negligence or breach of warranty of contractor/subcontractor/supplier in designing or building temporary or permanent works. Due to negligence of consultant or employer in design Due to matters outside the parties control, but which are insurable (e.g. fire, theft, vandalism) Due to matters outside the parties control, but which are not insurable (e.g. war) Consequential loss arising from above Exclusions, gaps & time limits in insurance covers
14 Types of Risks in Construction Projects cont'd Fifth: Risks relating to Government Policy & Public Interest Changes in taxes, labour and safety or other laws Delay or refusal of planning approvals, building permits, etc. Protests or legal action by pressure groups
Types of Risks in Construction Projects cont'd 15 Sixth: Risks relating to Conflict War, unrest, etc. Malicious damage, intimidation Seventh: Risks relating to Labour Demands Labour disputes and strikes Quality of labour
Types of Risks in Construction Projects cont'd 16 Eighth: Risks relating to Payment Varying rates of exchange. Delay in settling claims, certifying and effecting payments, and release of retentions. Insolvency of contractor or employer. Cash flow or funding constraints.
17 Types of Risks in Construction Projects cont'd Ninth: Risks relating to Inflation / Escalation Any element of cost or profit not covered by a price fluctuation clause. Replacement cost of plant and equipment. Tenth: Risks relating to Disputes Delay and cost of resolving disputes Lack of records. Imbalanced or ambiguous contracts
18 Risk Assessment The importance of Risk Assessment emanates from the importance of determining the costs and benefits relating to risks insofar as the allocation and realization of such risks, and thus enabling decision makers to make the appropriate decisions.
19 Risk Assessment can be done through the evaluation of the probability of occurrence and the potential severity of the risks.
Risk Allocation 20 The general principle is that all risks are Employer's risks except those that are explicitly transferred (allocated) to the Contractor in the contract against a reasonable price. The principles governing the allocation of risk to either party of the contract relate generally to the following factors: Which party is more able to control the risks? Which party can better forecast and evaluate risks? Which party can better bear the consequences of risks materializing? Which party better benefits or bears damage in the final outcome from the materialization of risks?
21 Risk Allocation cont'd In the application of the above principles, and with regard to the risks that are to be transferred (allocated) to the contractor, the following points should be considered: The contractor being capable of evaluating the allocated risks. The contractor being capable of controlling the allocated risks and reducing the probability of their occurrence. The contractor being financially capable of withstand the damages that may result from the occurrence of the allocated risks.
Some Risks Borne by the Contractor 22 Availability and cost of labour, materials, and equipment Timely completion Default of subcontractors and suppliers Errors in construction and non-complying work Compliance to safety requirements Normal weather conditions (time and cost) and exceptional weather conditions (costs only) Design of permanent works assigned to contractor Safety of methods and manner of construction Compliance of works with contract (except impossibility)
Some Risks Borne by the Contractor cont. 23 Correct setting out Protection of the works Trade marks and intellectual property Notices for claims Issuance and evaluation of Variations Delayed payments Dispute resolution procedures Changes in cost of labour, materials and plant Structural warranty Termination for the employer's convenience
Some Risks Borne by the Employer 24 Issuing drawings, instructions and approvals. Design faults (except contractor's design as per contract). Issuing information relating to subsurface and hydrological conditions. Unforeseen physical conditions and obstructions Safety, security and environmental protection with regard to work carried out by employer. Damages to the works resulting from the employer's risks. Fossils.
Some Risks Borne by the Employer cont. 25 Suspension of work. Site possession. Justified extension of the time for completion. Issuance and evaluation of variations. Payment to nominated subcontractors Cost of finance, slowing down and suspension, and termination of contract if payments to contractor are delayed. Assignment of subcontracts if contractor's employment/contract is terminated. Force majeure.
Some Risks Borne by the Employer cont. 26 Dispute resolution procedures. Changes in costs of labour, materials and plant, changes in legislation and changes in the currency rates of exchange. Structural warranty. Termination of contract for the employer's convenience.
27 Conclusion Risk allocation between the two parties to the contract should be carried out in accordance with the principles set out above. Proper allocation of risk is very important to minimize loss and damage to both parties to the contract. The awareness of both parties to the contract of the risks allocated to each, the proper allocation of such risks and the proper management of those risks are very important issues that lead to minimizing loss and damage on both parties and to the avoidance of contractual and legal disputes.