Construction Contracts: Risk allocations and what to look for

Introduction

Construction projects are complex endeavours that involve numerous risks and uncertainties. In order to effectively manage these risks, construction contracts include various provisions allocating these responsibilities and liabilities between the parties. These include providing contractual provisions and risk allocations in clarifying the roles and responsibilities of the parties, reducing risk and ensuring project success.

What is Risk Allocation

Risk allocation refers to the process of assigning the various risks associated with a construction project to the party that is best equipped to manage and control them. The objective is to balance the allocation of risks thereby protecting the interests of the parties involved and ensuring project success. Whilst unambiguous risk allocation is crucial to avoid disputes, maintaining project timelines and overall success of a project, effective management of these risks by the responsible party is imperative to achieving these goals. Managing risks is a separate topic and will not be dealt with in detail in this article.

What to look for? The key contractual provisions

Scope of Work: A good practice is to include a detailed description of the scope of work in the contract documentation. The scope of work document should clearly define the scope of the works and any other specific requirements including specification criteria, material requirements, quality standards and industry codes to be met. The design responsibilities are sometimes highlighted elsewhere in the contract documents, however, if there are further specific requirements regarding design responsibilities, these should be clarified in the scope of works document.

Indemnification and Liability: Indemnification provisions specify which parties are responsible for indemnifying and defending the other party against claims, damages or liabilities arising from the project. It is recommended that the parties familiarise themselves with the allocation of liabilities in this regard and that the responsible party ensure that they have sufficient cover for these risks. This may include insurance cover or a Contractor ensuring that the project contract price covers the risks allocated to them.

Force Majeure: Force Majeure clauses address events or circumstances beyond the control of the parties, such as natural disasters, strikes, or government action which may impact the project timelines or costs.  Force Majeure clauses seek to modify the South African common law concept of impossibility of performance. Although there may be certain elements of a force majeure clause that may be thought to be a construction standard, these clauses need to be examined to ascertain the extent that they allow for non-performance.

Change Orders and Variations: Scope creep is a risk that many projects face. If not properly managed, scope creep leads to added costs and time for completion. It is essential to understand the variation or change order provisions to establish the provisions for requesting and approving  changes, the associated procedures for pricing changes, time adjustments and the notice requirements. Following the correct processes will enable a reduction of scope creep, fair compensation and time allocations for additional work.

Payment Terms and Retention: Cash flow is the lifeblood of any construction project. Understanding the payment terms, invoicing process and time for payment will assist in managing cashflow. Retention provisions provide the percentage of the payment that may be withheld until a specified milestone has been reached e.g. final completion. They provide security for the employer while securing the contractor’s payment rights. Understanding these provisions is imperative in cash flow management and meeting project commitments. Non-payment may also give rise to certain rights to the affected party, and it is advisable to be familiar with these.

Insurance and Bonds: Contractual provisions relating to insurance and bonds specify the respective party’s responsibilities to obtain and maintain certain insurances and bonds. These provisions allocate the risks associated with property damage, personal injury or non-performance ensuring that the parties are adequately protected. It is imperative to comply with these provisions. If there is inadequate cover, dire consequences may ensue.

Penalty Provisions: Time for completion is an important aspect of a construction project and also one of the key considerations in planning a project and the coordination of works between the different role players. It comes with an array of financial impacts. Delays in completion may have adverse financial impacts on the employer. As such, penalty amounts are negotiated to reflect a pre-determined amount for liquidated damages.

Extension of time clauses: All standard form contracts specify the grounds for extensions of time and the processes that are required to be followed. Depending on the form of the contract, there may be grounds for extensions of time with and without costs. These clauses need to be properly understood to ensure timely compliance with their requirements. Non-compliance with the requirements of these clauses may lead to time barring and the loss of entitlement to claims.

Dispute Resolution: Dispute resolution clauses feature prominently in standard forms of contract. These clauses outline the provisions of alternative dispute resolution mechanisms, such as mediation, amicable settlements, adjudication or arbitration. Effective dispute resolution mechanisms coupled with a proper understanding thereof, facilitate timely and cost-effective resolution of disputes, minimizing project delays and additional costs.

Conclusion

Risk allocation and contractual provisions are critical components of construction contracts. The above provisions are an indication of the more prominent typical clauses found in a construction contract; however, they are not an exhaustive list. By clearly defining and understanding the risk allocation between the parties, in a manner that contributes to enhancing collaboration, and minimising potential legal and financial risks, successful projects can be achieved.

Construction contracts may be considered a complex web of clauses and it is recommended that advice pertaining to the landscape of these provisions is sought from a legal professional or the Association. All members of the Association are eligible for free construction contractual advice.

Bilaal Dawood

Head: Membership Services