As Quantity Surveyors, understanding risk is not only part of our job, but arguably one of the most important features. Not grasping how risk is allocated on a project can be detrimental to profitability for contractors, and cost for clients. It can lead to budget overruns, inaccurate forecasts, and cash flow issues. How can you submit an accurate price, if you don’t understand risk? How can you know if an event constitutes change? It really is fundamental to our role. We explore how construction contracts allocate risk, ensuring you’re ahead of the curve when it comes to risk management.
Risk Allocation in Construction Contracts
• Variations: Contracts list events that change programme or price, such as Compensation Events (NEC) or Relevant Events/ Relevant Matters ( JCT). Understanding these helps identify what risks are covered and which ones can change the contract sum.
• Payment Mechanism: Understanding how work is paid is vital. For example, lump sum contracts put productivity risk on the contractor, while cost reimbursable contracts shift the risk to the client. Know when to apply each mechanism for successful financial outcomes.
• Standard Form Amendments: Amendments to clauses made using Z clauses in NEC or the schedules of amendments in JCT can change the balance of risk. Understanding these amendments is key. If unclear, seek legal advice to understand the impact on the contract.
• Payment Terms & Retention: Payment terms outline the agreed schedule between client and contractor, long payment terms risk cash flow issues for the contractor. Retention is a portion withheld until the work is completed adequately, ensuring defects or incomplete work are addressed. Similarly, retention clauses risk cash flow issue for the contract.
• Design Responsibility: Design responsibility refers to the party accountable for ensuring that the project design meets required standards. It also ensures the build is structurally sound, and compliant with legislation. Knowing who has responsibility for design is a vital consideration.
• Construction Bonds: Bonds provide financial security for the client if the contractor fails to meet obligations. A performance bond guarantees project completion in accordance with the contract requirements. A retention bond ensures defects or incomplete work are addressed without withholding cash retention.
• Collateral Warranties: These extend the contract’s rights and obligations to third parties, ensuring work meets standards and holding the contractor accountable for defects after project completion.
• Insurance & Indemnity: Insurance provisions manage risk, covering public liability, professional indemnity, and more. Indemnity clauses define which party covers losses, ensuring financial risk is mitigated in case of accidents or disputes.
• Completion Liability: If a project runs over its completion date, delay damages may apply, often in the form of liquidated damages. These pre-determined estimates of losses can be passed down to the contractor if works exceed the contractual completion date.
• Post Completion Liability: The defect liability period defines who is responsible for defects after work finishes, outlining the contractor’s ongoing obligations.
