Risk management
Contractual risk transfer is one form of risk management, and has been employed in the construction industry for many years. It involves the allocation or distribution of the risk inherent to a construction project among contracting parties.
Risk allocation in the construction industry is established by the construction contract, so the importance of this contract cannot be over-emphasized. Ideally, the parties in the contract will assign risks and liabilities to the party best-equipped to manage and minimize them. The contracting process provides the vehicle for each party to negotiate, define, and limit its rights in accordance with its goals. The risk and responsibilities associated with a specific project must be clearly allocated within the contract, which serves as a legal framework between the parties and will establish which party has assumed or negated a particular risk in connection with the project.
A number of factors are key to successful risk management:
- Risk identification.
Prior to negotiation, each contract party should assign an experienced person to identify areas of contractual risk.
- Impact analysis.
Given risks influence all aspects of a project, each party should quantify the impact a risk will have on the project cost, schedule, quality, and profit.
- Response system.
Each party should develop a process for formulating risk management, mitigation, deflection, and contingency planning strategies.
- Application of risk management systems.
The contract parties’ risk management strategies and goals should be reflected in the language of the contract. In risk transfer negotiation, parties should remember if they ask for nothing, they get nothing.
The risk management plan is the product of risk mitigation. It should include a list of action steps to:
- Eliminate or reduce the probability of a threat occurring.
- Mitigate the impact of the threat if it does occur.
- Assure or increase the probability of an opportunity occurring.
- Increase the impact of an opportunity if it does occur.
In addition to action steps, the plan should include ‘trigger points’ indicating when each step is to be executed. It should also define what to monitor to determine the trigger points, and may require action to reduce, transfer, or eliminate risk.
One of the key places to examine risk in the contract documents is in any indemnification clauses. Indemnification, also known as an agreement to hold harmless, may be defined as the obligation of one party (i.e. the indemnitor) to reimburse another party (i.e. the indemnitee) for the losses the latter incurs or damages for which it may be held liable. Indemnification issues arise frequently in construction litigation. Their impact can be significant, because indemnification often shifts the burden of loss or responsibility from one party to another.
Although the contract serves as the principal risk management vehicle, parties should begin managing and minimizing risk long before the contract is signed. To avoid inequities, all parties should come to the negotiating table with some idea of their risk management goals. Unfortunately, most construction contract parties pay insufficient attention to risk management process requirements. This process requires a systematic and practical methodology, and contract parties must acquaint themselves with the risks they are to manage, as well as developing specific mitigation strategies. A good place to begin with contract documents and risk management is AIA A201, General Conditions of the Contract for Construction. Project managers should evaluate each word related to risk.
The next and final article in this series discusses the project manager’s role and responsibilities as an expert witness.
Norman F. Jacobs, Jr. formed Jacobs Consultant Services in 1981 to provide a variety of construction services including cost management, schedule control assistance, project management, and claims preparation and negotiation. Prior to this, Jacobs provided design-build, construction management, and general contracting services for over 30 years, in a variety of capacities ranging from estimator to president and board member. He has chaired Virginia’s Associated General Contractors (AGC) Documents Committee, has presented seminars on construction legal subjects with the Virginia Bar Legal Committee, and is a past president of the CSI Richmond Chapter. Jacobs can be reached via e-mail at JCSCPM@aol.com.
