De-risking vs. Project Outcomes 2

Thursday, January 1st, 2015
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I ran into an old friend of mine at the airport recently who runs a specialist technical contractor.

I was off to work on an oil and gas claim for a main contractor who had signed a highly onerous contract. My friend was going to halt a tender process where his prospective principal was trying to force him down the same road, to take unmanageable risk for the sake of so-called “de-risking” of the project.

My friend was hurting but he knew it was the right thing to withdraw; I agreed. He had won the tender on the basis of his firm’s expertise, track record, and its excellent product. Many of the deliverables depended on his principal handing over equipment, information and authorisations first. Yet the principal’s lawyers aimed to penalise my friend’s business for delay and failure to perform whether it was his fault or not. Where the principal  delayed delivery of an excavator, and as a result, my friend’s business was unable to modify it by the date in the contract, my friend was liable for liquidated damages.

That sort of term is clearly nonsense in practical reality but something I see a lot of in my world of construction disputation.

Causes fall into a few categories:

Category 1: Employers are inclined to divest themselves of all project risk, even risk they can manage where their contractor cannot. The effect of this approach can vary. Where it involves big work and main contractors, it tends to eliminate the very capable and good value middle tier from the field. This leaves only the majors, which can take a statistical approach to onerous projects and have large commercial teams engaged to manage out risks during the works and prepare claims of course. It also leaves in the game the small companies, set up specially to manage these risks, which will be expendable if all goes wrong. The people suffering here are the mid-tier contractors and the principals because the tender competition will be driven by factors other than the work at hand.

Category 2: Lawyers working for the principal often lack a practical commercial understanding of the construction space. Construction projects are highly complex transactions with many moving parts and interested parties. My experience is that some law firms have a standard set of terms for principals but seek to transfer more risk each time the terms are rolled out. Although this allows them to illustrate their supposed contribution to the project, it can result in commercially unworkable contracts.

Category 3: The principal could be concerned that its own team lack the capability required to play a significant guiding role in a project. That is understandable where the principal  is a one-time purchaser of construction services. It is not understandable if the principal  is a routine letter of serious technical contracts. In either case there are good consultants around. Set them up to advise on, and deliver, the most cost-effective outcome, not the most de-risked (or re-risked) one.

The principal my friend was trying to deal with will appoint a technical service provider. However, the only provider still in the frame (all the others having been frightened off by the principal’s de-risking efforts) has a product which is far less capable and adaptable than the technical solution the principal’s engineers need. There are implications in de-risking for operations which go beyond the price paid for the solution.

Pragmatic expert legal advice and a robust approach to commercial risk management will result in the right team being appointed at the right price. If the arrangement is wrong from the very beginning on a project, there is little hope of the system running smoothly.

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  1. Dick Rogers

    An arrangement whereby a contractor assumes risk beyond which they could reasonably control and indeed in areas which the principal themselves could reasonably control seems bound to end up in a dispute when something inevitably goes wrong and it sounds as though the contractor in question would be right not to sign.

    I wonder, if push came to shove, would these kind of provisions actually hold up in court?

    • Sarah Gerber

      I can't speak to court, but in my experience, working in residential construction, any problems which result in fines result in the larger companies planned to absorb cost in later projects (where engineers or contractors are doing frequent jobs for the same principal) and smaller companies simply going under because they don't have available cash. It's an unfortunate side of the construction business that doesn't benefit anyone — the principal is 'de-risking' to avoid liaibility and save money but frequently doesn't end up with the best service or product to do the job.