Where does the continued drive to mitigate risk in construction contracts stem from?

It might be the banks, but regardless of provenance, it is a bandwagon most procurers are jumping on. Look at any standard forms of contract for construction contracts along with standard (or typical) contract terms and conditions and there is an increasing trend towards higher levels of securities being sought. But how much is too much?

Like most risk, insurance and price-related matters, there is an elastic relationship between the benefit realised and the cost of obtaining it. This relationship seems to be getting a little out of kilter.

Most standard forms of contract require as a minimum, the following:

  • liquidated damages (LDs)
  • retentions
  • contract works insurance (sometimes joint names, sometimes not, sometimes client procured, sometimes not)
  • plant, equipment and motor vehicle insurance
  • professional indemnity (PI) insurance (rare these days to see a project completely absent of any contractor design, itself risk mitigation to a degree)
  • public liability (PL) insurance
  • performance bonds (either conditional or unconditional/on demand)
  • warranties on materials, performance and workmanship
  • guarantees for the same
  • payment for materials on site only
  • indemnities

The provision of each of the above carries both a cost and a benefit. Some accrue only or predominantly to the contractor – such as plant and motor vehicle insurance. LDs are exclusively an employer benefit, barring a very jaundiced view things.

Regardless of to whom the benefit accrues, the provision of the above will be considered at tender stage and due allowance made for each of them, either as a specific cost, such as LDs, or as an overhead cost forming part of the prelims. The point is, they aren’t free and like a car, the more you want from it, the more it’ll cost.

The other important consideration is that when pricing a tender, the contractor will take account of not only what is expressly required but what is implied by way of attempted risk transfer. This is an important, slightly intangible cost that may not be readily apparent in any bid.

The more the client attempts to transfer liability/risk, the more the contractor will consider the overall risk profile of the contract. If there are cumulative hints that it may be adversarial, or biased, it is likely to be reflected somewhere in the price.

It behooves any sensible client to ask, what do we really need to protect ourselves from? Some are givens. Here are my views on items in the above list:

  • LDs: essential (even in alliances)
  • retention: not essential. It hinders cash flow and can be a significant sum on a large project. There are other remedies available if required.
  • CWI: essential. Try getting funding without it.
  • PI insurance: essential
  • PL insurance: essential, though there may be overlap between the cover carried by the client and that carried by the contractor. PL insurance is generally not expensive to provide.
  • performance bonds: debateable. They can be negated by rigorous pre-qualification and financial D&B type checks. However, if used, they should be conditional, as there is too much open-ended risk with unconditional bonds. Strangely, in New Zealand, unconditional bonds are not uncommon, whereas they certainly used to be hard to get in the UK. The danger of vexatious calling of a bond is probably slight with most professional organisations but as longs as it lies out there as a risk it will carry a dollar value.
  • warranties, guarantees, indemnities: grouped together here, as they are similar and a lot what they offer is already covered by statute (fitness for purpose, workmanship, materials compliance with code, and so on.) There is also extant common law protection available for the client by way of tort which links them to the subcontract chain.

Clients typically eschew payment for materials off-site and although it is now a risk that is reduced by the Personal Properties Securities Register, it is not eliminated entirely. The waters here are muddied by the lodgement of multiple registrations that are generic (i.e. against the company’s general assets, rather than product specific).

In extreme instances (a tunnel boring machine is a good example) not allowing this this can result in over a year’s worth of cost being carried before recovery begins. With instances such as this, there is a temptation to load (or try to load) prelims, which is somewhat understandable. This may be best dealt with by open and honest discussion at tender stage. However, if expressly excluded, it will impact the tender price, particularly where large plant or equipment with long leads is being procured or specified.

In the throes of assessing a lawyer’s advice and setting tendering conditions, sometimes the essence of what the client ought to be trying to do gets lost. The underlying aspiration appears to be to achieve a fair balance of allocation of risk, cognisant of the contractual circumstances prevalent and mindful of the prevailing mind-set in the market place.

As ever, economic conditions dictate what might reasonably be expected or asked for and too biased an approach will just result in zeroes on the end of the tender price.